Sham trusts and piercing the veneer-the difference in South African law

Transcription

1 Sham trusts and piercing the veneer-the difference in South African law

2 Introduction Marius de Waal in his in his discussion on the differences between a sham trust and an attempt to pierce the trust veneer (or go behind the trust form as he describes it) says the following: [2012 The Rabel Journal of Comparative and International Private Law 1-23] It has been argued that sham situations on the one hand, and abuse situations on the other, are approached from different theoretical angles. In the case of a sham, the question is whether a valid trust has been created at all. Here, the emphasis falls on the requirements for the creation of a valid trust; specifically that the founder must have the intention to create a trust. In the case off an abuse situation, the premise is there is a valid trust, but there may exist a justification for going behind the trust, and ignoring the trust for a particular purpose. This approach was given judicial support in the recent case of Van Zyl N.O. v Kaye N.O ( SA 452 (WCC) where the court said:

3 Indeed, the applicants approach renders it necessary to highlight that establishing that a trust is a sham and going behind the trust form entail fundamentally different undertakings. When a trust is a sham, it does not exist and there is nothing to go behind. In my view, the applicants have confused and conflated the concepts in their founding papers. The court then went on to say: Going behind the trust form, on the other hand, entails accepting that the trust exists, but disregarding for given purposes the ordinary consequences of its existence. This might entail holding the trustees personally liable for an obligation ostensibly undertaken in their capacity as trustees, or holding the trust bound to transactions ostensibly undertaken by the trustees acting outside the limits of their authority or legal capacity as such

4 The court then concluded this discussion on the distinctions of the two different approaches at paragraph 22 as follows: Going behind the trust form (or piercing its veneer, as the concept is sometimes described) essentially represents the provision by a court of an equitable remedy to a third party affected by an unconscionable abuse of the trust form. It is a remedy that will be afforded in suitable or appropriate cases. The notion of the provision of such a remedy has been postulated as a desirable development in our law I suspect that, rather like the position with piercing of the corporate veil in the case of companies, closely defining the applicable principles in the cases in which it is afforded or withheld may prove elusive. That is why I consider it appropriate to describe it as an equitable remedy in the ordinary, rather than technical, sense of the term; one that lends itself to a flexible approach to fairly and justly address the consequences of an unconscionable abuse of the trust form in given circumstances. It is a remedy that will generally be given when the trust form is used in a dishonest or unconscionable manner to evade a liability, or avoid an obligation

5 This has now become the accepted academic view in SA trust law, but decisions from the courts are still contradictory: Pringle v Pringle [Unreported case, 2007] This case involved a division of assets in terms of the accrual system on divorce. The issue for the court was whether the assets of a family trust could be regarded as assets of the defendant for purposes of the accrual system. Although this case involved section 3 of the Matrimonial Property Act ( The MPA ), and not the Divorce Act, and the court acknowledged that it did not have a discretion in terms of the MPA, it concluded that: I see no reason in principle why the assets of an inter vivos discretionary trust created during the marriage may not in appropriate circumstances be taken into account in the assessment upon dissolution of a marriage of the accrual of the spouse s respective estates in terms of this section

6 BC v CC [ SA 562 (ECP)] This matter involved an application for the striking-out of certain portions of plaintiff s particulars of claim. The plaintiff sought an order that the value of the assets in trust be taken into account in determining the value of the accrual of the first defendant s estate as at the dissolution of the marriage. The defendant again raised the issue that the MPA is different to the Divorce Act and does not allow the court a discretion. The court said that: Where a trust is in fact a sham and where the trust assets are de facto the assets of a spouse in a marriage relationship, the value of the assets ostensibly held by the spouse on behalf of the trust may be taken into account in determining the accrual in the estate of the spouse concerned The court then went on to say that: As it was pointed out during argument the plaintiff does not seek transfer of the assets held on behalf of the trust to herself. She only seeks that the value thereof be considered in determining accrual. I do not think that this calls for exercise of discretion. The issue simply entails determining from the evidence what assets fall to be considered in determining accrual.

7 Such determination is in my view the same in both the Matrimonial Property Act and the Divorce Act. It seems to me that generally a benefit enjoyed by a person from an asset adds value to the estate of that person. I am not persuaded therefore that value derived or enjoyed by a spouse from assets of a trust should be ignored or that the court is precluded under s 4 of the Matrimonial Property Act from considering such value on the basis that the intention of establishing the trust is not disputed....i am also not persuaded that in this case the court is precluded from considering the value of such assets because there is no express prayer that the assets 'be deemed' to be that of the first defendant. The basis on which the claim is made by the plaintiff is clear from the summons... The application to strike out was therefore dismissed with costs Both cases gave no authority for their decision and are not logical. Seemed to say the trust was a sham, but then did not ignore the trust?

8 Miller and others v Miller [2014 JOL (KZP)] One of the more recent cases on this topic Husband and Wife were in the process of a divorce. The wife claimed that the marriage was subject to the accrual system that was established in terms of Chapter 1 of the MPA, and sought an order directing her husband to pay her an amount equal to 50% of the amount by which the accrual of his estate exceeded that of her estate. The main issue of dispute before the court was whether the assets in a family trust could be taken into account in the determination of the accrual of the husband s estate, as contemplated in section 4 of the MPA. The husband took exception to this claim The wife pleaded that the Miller Family Trust [ The Trust ] was the alter ego of the husband and that its assets should be deemed to form part of the husband s assets for the purposes of determining the accrual of his estate. She did not claim that the trust assets were his property or part of his estate, nor that the trust was not a genuine one

9 The wife tried to use the Badenhorst case as precedent. The court noted that the court in that case had found that the husband had full control of the assets of the trust, and concluded that the value of trust assets had to be taken into account as part of the value of the husband s estate to determine what a just and equitable distribution would be. However the court in Miller stressed that the Badenhorst case involved a redistribution order in terms of the Divorce Act. The court in Miller felt, in summarising sections 7 (3) (5) of the Divorce Act, that it was plain that the Court has a wide discretion in determining what redistribution order should be made. However, the Badenhorst (and other cases relied on by the wife) had to be seen in the context of these sections of the Divorce Act. The court, importantly, concluded that the Badenhorst case must be seen in the context of the discretion afforded in the Divorce Act, and is therefore no authority for the principle that in calculating the accrual claim the assets of a trust can be taken into account in determining the accrual of one of the parties.

10 The court concluded by saying that the amount of the accrual claim is a pure mathematical and factual issue and not a matter of discretion. There is no discretion to include assets which are not part of the estate on the basis that it would be just to do so. If a trustee behaves improperly, the law provides a remedy. The court therefore upheld the exception to the claim that the trust assets should be taken into account. This judgement is in line with the Kaye case [to be discussed later], and the most recent judicial and academic opinion therefore, is that Badenhorst and Jordaan must be seen solely in the context of the Divorce Act, which explicitly gives the court a discretion to reach a decision based on what it deems just and that is equitable. These cases do not give the courts blanket authority to simply ignore a trust or pierce its veneer whenever it is alleged that the trust is being run as the alter ego of the founder or one of the trustees. NB-what about an equitable approach? What is most curious is that this approach does not seem to be widely followed by the courts in insolvency cases and cases where creditors are laying claim to trust assets..

11 Insolvency cases-first National Bank v Britz 2011 ZAGPPHC 119 One case where the court did expressly pierce the veneer or go behind the trust form. The case involved a matter where a creditor (the bank) was attempting to attach assets which the debtors claimed belonged to two trusts and not to them Two trusts-a trust A and a trust B-owned the debtor s movable assets and their residence. The bank, the creditor, was attempting to attach these assets as the debtors has nothing else to attach On the issue of Mr. and Mrs. B residing on the property which belonged to the B trust, and supposedly leasing it, the court had the following to say: They claim that they have leased the property from the B trust. They have, however, failed to produce any lease agreement, or to show its existence or furnish the relevant details of such lease agreement, or to justify their tenancy on the property of the trust.

12 Failure by Mr. and Mrs. B to attach to their papers proof of the existence of a lease agreement between said trust and them, or to furnish explanatory details of the alleged lease, or to produce the lease, leads to several inevitable conclusions. The first conclusion is that there is no such lease agreement between the B trust and Mr. and Mrs. B, and that Mr. and Mrs. B use the property, ostensibly owned by the trust, as their own personal property. Mr. and Mrs. B do not therefore regard the immovable property as the separate property of the trust. With respect to the movable assets that had been transferred to the A trust, the court said: With regard to 14 Trust, it was alleged by the applicant that, on account of the following facts, the alleged sale of the movable assets to the said trust was a simulated transaction; Firstly the said trust did not pay all the monies at all for the acquisition of the movable assets from the First and Second Respondents; secondly the said trust did not take physical delivery of the movable assets in as much as the movable assets remained in the physical possession and control of the First and Second Respondent.

13 The Court concluded by saying: The founder ought to have had a serious intention of establishing a trust and of transferring ownership of the trust assets to somebody who could control them. In our view, the founder failed to give sufficient indication that he had indeed relinquished control of the assets It is as clear as crystal from the authorities of Badenhorst v Badenhorst and Jordan v. Jordan supra that where the founder of the trust has completely disregarded the basic principal of the trust, in the name of equity, a court is entitled to know the trust as separate entity and declare that the trust assets must be seen as part of the personal assets of the founder This case subject to much academic criticism in SA, as it used incorrect authority [Badenhorst did not say this]. Also, did it use sham or pierce the veneer in the interests of justice?

14 However, it is submitted that this case is important for two reasons. Firstly, it is the first case where the courts have expressly allowed creditors to attach trust assets. Secondly, it is submitted that this case raised a new point of departure in which to attack trust assets-did the founder transfer ownership of the trust assets and relinquish control of the assets? This, it is submitted, is another angle of the substance versus form doctrine not only should it be investigated whether the founder intended to set up a trust, but on the other side it needs to be investigated whether the founder actually intended, in substance and in form, to hand over control of the assets to the trust. This is known in Jersey as the Donner et retenir principle Thirdly, the case seemed to bring in equity. This goes hand in hand with what has been discussed in the De Waal article and the Kaye case-piercing the veneer of a trust as an equitable remedy to prevent unconscionable abuse. So although the case used incorrect authority, it is submitted that the conclusion reached was correct. Clearly confused the issues of sham vs piercing the veneer however

15 Khabola NO v Ralitabo NO [2011 ZAFSHC 62] The court concluded that the parties intended to form a partnership, and that the trust was therefore simulated. It treated the entity as a partnership and held that the partners in a partnership have a right to sue each other. It seems clear that the court here treated the trust as a sham, even though the term was not used No authority given for judgment

16 Rees and Others v Harris and Others [ SA 583 (GSJ) This case involved an appeal against an order of the lower court, which granted, inter alia, an attachment order against two bank accounts and assets of a trust, the A trust, represented in the present proceedings by its two trustees, Rees and his wife Harris alleged in papers before the court that he had a claim against Rees, because he had lent and advanced R1m to Rees which remained unpaid. It was also alleged by Harris that the A trust had been misused by Rees as his alter ego One of the issues which the court had to decide, was whether the lower court had been correct when it confirmed the attachment of assets belonging to the A trust, on the basis that the A trust was the alter ego of Rees. The court felt that one of the key issues it had to decide was whether the assets of the A trust, could effectively be considered to be the assets of Rees

17 The court looked at the case of Land and Agricultural Bank of South Africa v Parker and others, which, it decided, led to the conclusion that the veneer of a trust can be pierced in the same way as the corporate veil of a company. The court went on to state that where the trustees of a trust clearly do not treat the trust as a separate entity, and where special circumstances exist to show that there has been an abuse of the trust entity by a trustee, the veneer must be pierced However, on the issue of proof, the court, went back to the basic issue-that Harris sought the attachment of assets of the A trust on the basis of the allegation that the A trust was the alter ego of Rees. It felt that although the A trust was run by Rees and his wife as the trustees, and Rees was the founder, in the present case Harris had not brought any primary facts to prove the misuse of the A trust. It was therefore impossible, on the facts put before the court, to draw the inference that the A trust was indeed the alter ego of Rees

18 The court concluded by saying that it felt that unlike the Badenhorst case it was not established that Rees was in full control of the trust. Therefore the claim against the trust failed on the facts. Although confusing to try and decipher whether the court was deciding whether or not the A trust had been proven by Harris to be Rees s alter ego or whether the evidence had established that the trust was a sham, no doubt that this application only failed on the facts. Had Harris been able to prove the facts, the court would have allowed the trust assets to be attacked, irrespective of on what grounds

19 The Kaye case This case involved the trustees of an insolvent estate seeking an order of the court to disregard the veneer of the Trust, or go behind it, to allow a property in the trust to be treated as assets in the insolvent estate. On the matter of Kaye having control of the trust, the court said the following: The allegedly delinquent discharge by trustees of their responsibilities thereby allegedly giving Kaye sole and unfettered de facto control of the Trust s asset, gave rise to the accusation by the applicants in their founding papers that the trust was a sham. While the description is understandable in loose terms, it lacks cogency in a legal sense in the face of the valid creation and continued existence of the trust. The maladministration of an asset validly vested in a properly founded trust does not afford a legally cognisable basis to contend that the trust does not exist, or that the asset no longer vests in the duly appointed trustees. Thus, for the applicants to be able to establish that the Cape Town property does not vest in the Trust they have to prove that the Trust was a sham. Holding that a trust is a sham is essentially a finding of fact. Inherent in any determination that a trust is a sham must be a finding that the requirements for the establishment of a trust were not met, or that the appearance of having met them was in reality a dissimulation

20 The court concluded this issue by saying that there was no reason to hold that the trust was not properly set up, or that the property did not vest in it The court then looked at the second method of attacking a trust, that of going behind the trust form, or piercing the veneer Going behind the trust form, on the other hand, entails accepting that the trust exists, but disregarding for given purposes the ordinary consequences of its existence. This might entail holding the trustees personally liable for an obligation ostensibly undertaken in their capacity as trustees, or holding the trust bound to transactions ostensibly undertaken by the trustees acting outside the limits of their authority or legal capacity as such Those cases will generally be manifested by trustees seeking, usually dishonestly, to use their formal non-compliance with the terms of the trust deed opportunistically to evade liability to a third party

21 Such cases are most likely to present..in a context in which the trustees treat the property of the trust as if it were their personal property and use the trust essentially as their alter ego an all too frequent phenomenon in certain family and business trusts in which the trustees are both the effective controllers as well as the beneficiaries. The remedy might entail the making of a declaration that a trust asset shall be made available to satisfy the personal liability of a trustee, but it does not detract from the character of the asset as one of the trust and not that of the trustee; the existence of the trust remains acknowledged. Going behind the trust form, or piercing the veneer is an equitable remedy to a third party affected by an unconscionable abuse of the trust form, and will be afforded in appropriate cases. The court quoted the Parker case as support for the notion that such remedy is a desirable development in SA law. It felt that such remedy will be used when the trust form is used in a dishonest manner to evade a liability or avoid an obligation

22 The court then went on to say that even if Kaye did treat the trust as his alter ego, that did not in itself make the trust a sham. It might give cause for Kaye s removal as a trustee, or render him personally liable for transactions concluded by him on behalf of the trust, or liable in delict to the beneficiaries, but it did not give the applicants a right, as trustees of Kaye s insolvent estate, to ownership of the trust asset. The Cape Town property still belonged to the trust The court then concluded this discussion as follows: In my judgment, the applicants attempt to go behind the Trust in the circumstances has been misconceived. They have not shown that the Trust was used dishonestly or unconscionably to evade a liability to them or Kaye s creditors. As explained earlier, in the factual context of the case, they could succeed in obtaining the relief they sought, which in reality had nothing to do with piercing the Trust s veneer or going behind it, only by showing that it was a sham or that the fixed property had not really been vested in the Trust. They failed to do either of these things..

23 Conclusion-at last clarity! This judgement is in agreement with the De Waal article-it breaks the attempt to attack the trust into the two approaches The trust could not be held to be a sham, as no evidence was led to show that it had not been validly set up or formulated Re the second approach, there was no proof that the trust had been used dishonestly or unconscionably to evade a liability to Kaye s creditors. Therefore no need to apply the equitable remedy. There was also another remedy open to the creditors-to pursue a claim against the trust on behalf of the insolvent estate The court indirectly referred to the third approach of attacking a trust, that of the transaction sham, when it said the applicants could only succeed by showing that the trust was a sham or that the fixed property had not really been vested in the Trust. This again, is raising the issue that even if the trust was validly set up, the substance versus form principle could still apply to the transfer of assets to the trust, and find that true ownership was never transferred in substance, as per the Britz case

24 The weight of academic opinion now follows this approach However, there is still confusion with SA Courts-most recent case: RP v DP and others 2014 (6) SA 243 (ECP) Another accrual case. Wife wanted to amend her counterclaim to the effect that the value of the assets of a trust established during the marriage should be taken into account in determining the accrual. Husband argued that the court was not permitted to exercise a discretion to include the trust assets in the accrual, as this went against the wording of the MPA. He therefore took exception to the counterclaim. Court said:

25 This will happen, for instance, in cases where the trust is a sham and for all practical purposes is the alter ego of the founder or trustee. In these instances the concept of separateness of trust assets may be found to be abused for illegal purposes such as tax evasion or to prevent or frustrate creditors' claims. I think it is important to note that the learned judge of appeal in Badenhorst supra, having examined the terms of the trust deed and the manner of control of trust assets and affairs, lifted the corporate veil in considering whether or not the court was entitled to take the value of trust assets into account when making a redistribution order. I do not read the Badenhorst judgment as any authority that it did so in the exercise of a discretion under s 7 of the Divorce Act. Sham or abuse of trust form? Can t be both! Badenhorst clearly did use section 7 of Divorce Act-line one of judgment reads: the crisp issue in this appeal is whether, when making a redistribution order in terms of section 7 (3) of the Divorce Act

26 Her claim, essentially, is that by virtue of first respondent's abuse of the trust form, many transactions resulting in the ostensible acquisition of trust assets held by first respondent as trustee allegedly on behalf of the trust, are simulated transactions because in truth and in fact those assets belong to first respondent and are assets in his personal estate and not in the estate of the trust. She effectively seeks the simulation to be set aside and claims an order that those assets be taken into account as personal assets of the first respondent in determining her accrual claim. The effect of setting the simulation aside is to regard those assets as what they truly are, namely assets in the personal estate of the first respondent ab initio. If so, they were never truly trust assets and were never in truth and in fact kept by first respondent in his capacity as a trustee for the benefit of the beneficiaries. The applicant claims that those assets must be treated where they have always belonged, namely in the private estate of first respondent, and should therefore be taken into account in determining her accrual claim against first respondent's personal estate under sections 3 and 4 of the MPA. In order to consider these claims, it is unavoidable that the court will have to pierce the trust veil.

27 The applicant repeatedly alleges in her founding affidavit that the trust is a 'sham'; that it is the alter ego of the first respondent; that he abused the trust form to acquire personal wealth; and that he failed to keep trust assets separate from his personal estate and enjoyment. Should the trial court find that a particular transaction is simulated in that the asset or assets in truth and in fact constitute assets in first respondent's personal estate, then it will pierce the trust veil and refuse to recognize the separateness of trust assets from the personal assets of the trustee. Finally, and as I indicated earlier, each case is only concerned with the facts of the transaction under attack in that case. The court is not required to necessarily set aside the entire trust as a simulated deed. It is only required to set aside those transactions which are proven to be simulated. Therefore, the order which a plaintiff seeks, namely that some or all of the assets in a particular trust be taken into account in determining the claim for accrual, will only apply to assets proven to be the subject of simulated transactions

28 I agree with Mr. Ford SC that these sections leave no room for any exercise of a discretion, and it is essentially an exercise in the mathematical calculation of the claim, if any The argument then concludes that it is only in the exercise of the court's discretion under s 7(3) of the Divorce Act that trust assets may be taken into account in making a redistribution order, and because there is no discretion under sections (3) and (4) of the MPA, trust assets may not be taken into account in determining the value of an accrual claim. Therefore, the judgments in Jordaan and Badenhorst supra which were concerned with redistribution orders under s 7(3) of the Divorce Act have no application to the facts of this case. The argument is premised on the fallacious hypothesis that the discretion to regard 'trust assets' as personal assets of the trustee is derived from the exercise of the court's discretion under s 7 of the Divorce Act. This is not so. The discretion to pierce the trust veil of separateness of trust assets from personal assets is derived from common law with its origins in company law, more particularly English company law as explained earlier. It has nothing to do with either the Divorce Act or the MPA.

29 Conclusion Court found the counterclaim not to be excipiable Judgment confused the issues of sham and piercing the veil-not sure in the end which one was applied Did not discuss the Kaye and Miller cases or the De Waal article. Seemed to go against academic opinion and both cases Could have simply used the second approach-equitable remedy to prevent dishonest or unconscionable misuse of a trust to evade a liability, as per the academic opinion. Therefore probably the correct decision, although, again, got there in the wrong way SA courts and academic opinion slowly starting to differentiate between the two concepts, although still much confusion