Do not undo a good structure through bad implementation

You will experience dire consequences if your trust is labeled as either a ‘sham trust’ (“smoke screen”) and ‘alter ego trust’ (extension of yourself). These terms are often used interchangeably to confusing effect. However, the two concepts are very different and should be distinguished from each other.

Alter ego trust

If you intended to create a trust, but you have dealt with the trust assets as if they were your own, then your creditors, SARS and soon-to-be-ex-spouse can attack the trust and have it labelled as an alter ego trust; in other words, an extension of yourself. Despite the fact that the trust does in fact exist, the Courts will disregard the trust and treat the assets as if they belong to you.

How do you determine an alter ego trust?

Look for signs of abuse, either in relation to the trust deed or in the actions of the trustee and/or founder. Possible signs are:

  • There is no independent trustee
  • The trust deed gives the founder or a trustee the power to appoint and dismiss a trustee
  • The trust deed gives the founder and/or trustee the power to amend the trust deed without the consent of all the trustees
  • The founder has retained some level of control in the trust deed
  • The trustee acts contrary to the terms of the trust deed
  • There is a dominant trustee who dictates how trustee decisions are made
  • The trustees are not acting with the necessary care, diligence and skill expected of them in terms of the Trust Property Control Act, 57 of 1988

Consequences of an alter ego trust

As a general rule, a finding of an alter ego trust on its own does not void the trust and does not extinguish the rights of beneficiaries. The trust exists, but the court will look through the trust (‘pierce the veil/veneer of the trust’) and hold the trustees personally liable.

In Rees and Others v Harris and Others [2011] JOL 28014 (GSJ) the court held that, in appropriate circumstances, the veneer of a trust can be pierced in the same way as the corporate veil of a company. In these circumstances, if it is demonstrated that a trustee who has de facto control of trust assets effectively acquired and owned such assets for his/her own benefit only, such assets can in appropriate circumstances be considered to be those of the said trustee.

Similarly, in Van Zyl NO and Another v Kaye NO and Another [2014] ZAWCHC 52, the court held: ‘Going behind the trust form … 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.’

Sham trust

A sham trust exists where the trust appears to have been established on the terms of a particular trust deed, but these terms do not reflect the parties’ (the founder’s and trustees’) true intentions, thereby misleading third parties about the true terms of the trust.

How do you determine a sham trust?

The starting point is to check whether the requirements for the creation of a valid trust are present:

  • The founder must intend to create a trust
  • His/her intention must be expressed in such a way that it creates an obligation
  • The trust property must be defined with reasonable certainty
  • The trust object must be defined with reasonable certainty
  • The trust object must be lawful
  • There must be independent and proper trust administration

Consequences of a sham trust

For a long time there was uncertainty about the consequences of a sham trust. The possibilities were:

  • The trust is void (i.e. it does not exist), as the party contracting with the trust was unaware of its true nature and thus should not be bound to it
  • The parties to the sham entered into it with an intention to mislead others, suggesting that the transaction should perhaps instead be treated as voidable (i.e. it could be declared invalid)

Our courts recently ruled that the consequence of a sham trust is that the trust is void from inception. In Van Zyl NO and Another v Kaye NO and Another [2014] ZAWCHC 52 the court held that ‘when a trust is a sham, it does not exist’.