Chapter 2
Core principles
of trust law

Sham trusts

P3 It is proposed that trusts legislation should not contain any provisions relating to finding that a trust is a sham trust.
Please give us your views on this proposal.

Current law

2.30Sham trusts and alter egos were addressed in the Second Issues Paper.72 A sham arises where a “trust” is created and is intended to appear to be a legitimate trust, but is not intended to affect rights and obligations of the relevant parties in the way that a valid trust would.73 The object of a sham claim is to attack the validity of the trust so that the assets will be considered the property of the settlor against whom a proprietary claim can then be made.74
2.31The leading New Zealand case on sham trusts is the Court of Appeal’s decision in Official Assignee v Wilson.75 In this case the Court dismissed the appeal on the technical ground that the Assignee had no standing to make a claim of sham. However, in obiter the majority considered the elements required for a sham, including common intention between the settlor and trustees to create a sham,76 particularly an intention to mislead.77 Other evidence may also be relevant to establishing a sham, including evidence of excessive control by the settlor and poor trust administration or documentation. The majority also concluded that alter ego trusts were not an independent cause of action, although evidence of settlor control was relevant to showing a lack of true intention to establish a trust, which may in turn help establish a sham.78 The decision in Wilson sets a high evidential bar for asserting that a trust is a sham.

2.32There is no provision on sham trusts in current legislation. There is a question as to whether the law on sham trusts, including the effect of a sham finding, should be addressed through legislation or left to the courts to develop.


2.33Submitters to the Second Issues Paper were divided as to whether the current law on sham and alter ego trusts was satisfactory.79 Issues raised with the state of the current law included the view that it was unclear and uncertain; that it allowed trusts to defeat broader public policy objectives; that Wilson required too high a standard for proving a sham trust such that it was virtually impossible to do so; and that the ratio of Wilson was incorrect as to the standing of the Official Assignee to challenge a trust when the settlor is the bankrupt.

2.34There is also the more general concern that there are some trusts that have not been set up to run as proper trusts, or are not functioning as such. This includes the situation where settlors/beneficiaries are receiving the benefits of access to the property or directing the management of the property, as if they were the legal owners, but are protected from the responsibilities and liabilities of legal ownership. The sham argument has been used to try to address these types of situations, albeit usually unsuccessfully. There is a further issue as to the effect of a failure to comply with certain elements of proper formal trust management, such as resolutions, minutes and accounts.


2.35The Commission has considered the option of a provision on sham trusts that would set out a list of relevant factors for a court to look at when assessing whether or not a trust is a sham.80 Submitters had differing views on whether sham trusts should be addressed in legislation. Some submitters considered a legislative definition or statutory test for a sham would be helpful. Other submitters were reluctant to see the law on sham trusts included in legislation and considered it should be left to the courts to develop.
2.36Our view is that a provision on sham trusts is unnecessary. Other proposed reforms to trusts legislation, including setting out the definition of a trust, the requirement of the three certainties for the creation of a trust, and trustees’ duties,81 are sufficient to clarify the roles of settlor and trustees and encourage proper trust management.

2.37Nevertheless, we have weighed the competing arguments for and against setting out a legislative provision on sham trusts. The advantages would be to provide guidance and education to settlors and trustees; to clarify the law and provide more guidance about considerations for whether a trust is a sham; and to give more certainty about the appropriate evidential standard. More widely, it could prevent the undermining of public policy objectives in terms of people avoiding the responsibilities associated with a trust, and provide an effective mechanism to respond when a trust is not operating as a genuine trust. It could also better preserve the integrity of the trust concept. A legislative provision could be a faster way of addressing these issues than waiting for the courts to develop principles through case law.

2.38There are also a number of disadvantages or difficulties with such a provision. There is a concern that it could be inflexible compared with a judicial response, and could constrain judges from making appropriate findings in some cases. A number of submitters considered that shams are more effectively dealt with in the courts under existing law. They considered that the existing law is adequate and courts are better placed to respond since issues are likely to be fact-specific and involve a variety of scenarios, which would be hard to cater for in legislation.

2.39Some submitters also held the view that the concept of a sham is not well developed enough in a trust context to warrant legislative intervention. A provision could raise conceptual disputes that it would be helpful for the courts to develop and resolve rather than a legislative intervention. It could also present practical and operational issues that could be hard to resolve adequately in legislation, and could involve technically difficult drafting.

2.40There is a further concern that a sham provision could create unintended uncertainty about the validity of large numbers of existing trusts, which would lead to additional disputes requiring judicial resolution. Finally, it is possible that the issues with the use of a trust that underpin a claim of a sham are in fact not issues with the trust at all but rather lie in other areas such as relationship property or insolvency, and the problems are better dealt with in those areas rather than in trusts legislation.

72Second Issues Paper, above n 54, at ch 4.
73J Palmer “Sham Trusts” in Butler (ed) Equity and Trusts, above n 61, 393 at 396; based on the sham concept as discussed in a general commercial context by Lord Diplock in Snook v London and West Riding Investments Ltd [1967] 2 QB 786 at 802.
74Palmer, above n 73, at 394.
75Official Assignee v Wilson [2008] NZCA 122.
76This requirement of common intention has been the subject of some debate and criticism: see for example, J Palmer “Dealing with the Emerging Popularity of Sham Trusts” [2007] NZLR 81; J Palmer “What makes a trust a sham?” (2008) NZLJ 319 and Matthew Conaglen “Shams, Trusts and Mutual Intention” [2008] NZLJ 227.
77Official Assignee v Wilson [2008] NZCA 122 at [26].
78At [72]. Sham trusts were considered recently in KA No 4 Trustee Ltd v Financial Markets Authority [2012] NZCA 370, albeit only in a strike-out application. Here the Court of Appeal declined an appeal against the High Court’s decision not to strike out a claim that a trust was a sham. The Court considered there was an arguable case of sham (although the pleadings needed amendment regarding the consequences of a finding of sham, at [53]).
79Submitters that considered it satisfactory included Auckland District Law Society, WHK, Ernst & Young, KPMG; those that considered it unsatisfactory included the Ministry of Economic Development, the Ministry of Social Development, the NZLS, Tobias Barkley, Chapman Tripp, Peter Kellaway, and the Trustee Corporations Association.
80Based on those set out in the Second Issues Paper, above n 54, at [5.47].
81See ch 3.