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Sham Trusts and the Grand National

Mark Warwick QC of Selborne Chambers explains the hurdles that need to be cleared in order to establish that a trust is a sham in the light of the judgment in ND v SD and Others (2017) EWHC 1507 (Fam).

Mark Warwick QC
of Selborne Chambers

Establishing a sham trust is rather like finishing the Grand National.  Each involves overcoming a series of hurdles.  The very recent decision of Mrs Justice Roberts, namely ND v SD and Others [2017] EWHC 1507 (Fam), serves as a warning to any spouse who is minded to challenge a trust as a sham.  The legal hurdles are high, and the spouse who falls at any hurdle can find the negative costs implications are severe.  In this article it is proposed to use ND v SD as a case study, particularly because it includes a comprehensive and clear summary of the law regarding shams.

In ND v SD, in the course of disclosure in financial remedy proceedings, the husband (SD) produced an offshore trust deed dated 3rd August 2007 ("the ABC Trust"), to which he was a party (as settlor). The trustee was an overseas trust company (Y Trustees Limited).  The wife (ND) knew nothing of the ABC Trust.  She was deeply suspicious of it, particularly because it placed most of the husband's substantial assets (in the form of shares in property companies) in an irrevocable trust.  As far as the wife was concerned her husband had managed his affairs without reference to any trust. The trust deed was no more than a meaningless piece of paper.

The wife decided to challenge the trust, contending that it was a sham.  On 29th July 2015, on the wife's application, a preliminary issue was directed, and Y Trustees Limited, together with PH (an employee of the overseas lawyers who had created the trust) were joined as respondents.  As time passed certain other questions were added into the preliminary issue; however the allegation of sham remained "centre stage". 

After the usual interlocutory steps, the issue came on for trial in December 2016. The trial lasted two weeks.  No expense was spared. Both husband and wife retained three counsel (including chancery juniors), and the overseas trustee and PH, retained leading counsel of their own (being the author of this article). 

The judgment was handed down on 21st June 2017.  It extends to 264 paragraphs.  Some of the facts are colourful, not least the disclosure to the wife's solicitors of substantial privileged information relating to the trust by an employee of the overseas lawyers (who was obviously in gross breach of her professional obligations).

The interested reader can discover the factual detail from the judgment.  One factual detail worth recording is that some years after executing the 2007 trust deed, on 27th March 2014, the husband, together with PH, executed a second trust deed.  This purported to declare a trust in respect of some of the same shares as had been placed in trust by the 2007 trust deed.  On the husband's own case, the 2014 trust deed was intended to give a false impression to third parties, and was indeed a sham.  This was a point not surprisingly heavily relied upon by the wife.  The importance of the case to the lawyer however lies in its exposition of the law and it is to the law that this article now turns.

As will be seen, the judge not only set out the law regarding shams in a comprehensive and clear fashion, but she also ruled upon a novel (but unsuccessful) legal submission advanced on behalf of the wife.

The judge's primary comments upon the law are to be found at paragraphs 176-190 of her judgment.  She began with the famous passage from the judgment of Diplock LJ in Snook v London & West Riding Investments Limited [1967] 2 QB 786, at page 802.  The key portion of this passage is that:

"For acts or documents to be a "sham", with whatever legal consequences follows 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."

After Snook Mrs Justice Roberts then cited "five fundamental principles", in relation to sham acts or documents.  She took these from the judgment of Arden LJ, in Stone v Hitch [2001] EWCA Civ 63.  The five principles justify citation in full and read as follows:

"65. First, in the case of a document, the court is not restricted to examining the four corners of the document.  It may examine external evidence.  This will include the parties' explanations and circumstantial evidence, such as evidence of the subsequent conduct of the parties.

66. Second, as the passage from Snook makes clear, the test of intention is subjective.  The parties must have intended to create different rights and obligations from those appearing from (say) the relevant document, and in addition they must have intended to give a false impression of those rights and obligations to third parties.

67. Third, the fact that the act or document is uncommercial, or even artificial, does not mean that it is a sham.  A distinction is to be drawn between the situation where the parties make an agreement which is unfavourable to one of them, or artificial, and a situation where they intend some other arrangement to bind them.  In the former situation, they intend the agreement to take effect according to its tenor.  In the latter situation, the agreement is not to bind their relationship.

68. Fourth, the fact that parties subsequently depart from an agreement does not necessarily mean that they never intended the agreement to be effective and binding.  The proper conclusion to draw may be that they agreed to vary their agreement and that they have become bound by the agreement as varied: see for example Garnac Grain Co Inc v H.M.F. Faure and Fairclough Ltd [1966] 1 QB 650, 683-4 per Diplock LJ....

69. Fifth, the intention must be a common intention: see Snook's case above."

The judge then cited Neuberger J in National Westminster Bank PLC v Jones (2001) 1 BCLC 98.  That learned judge made two particular points in the following passage:

"One should not lose sight of the fact that there is obviously a strong presumption, even in the case of an artificial transaction, that the parties to what appear to be perfectly proper agreements on their face intend them to be effective, and that they intend to honour and enjoy their respective obligations and rights.  That that is so is supported by the fact that an allegation of sham carries with it a degree of dishonesty, and the court should be slow (but no naively or unrealistically slow) to find dishonesty."

Mrs Justice Roberts emphasised the above comments by saying, at paragraph 184:

"Thus, two headline points emerge at the outset: (i) there must be a dishonest intent before the court will find an instrument to be a sham, and (ii) where instruments or agreements are properly and formally drawn (i.e. "perfectly proper agreements on their face") absent dishonest intent, there is a strong presumption that the parties intend to honour their rights and obligations thereunder".

As paragraph 186 she continued:

"The next headline point which emerges from both Jones and Stone v Hitch is this: before transactions or documents will be construed by the Court as sham transactions, all the parties to them must share a common intention that the documents themselves will not create the legal rights and obligations which they give the appearance of creating".  The emphasis was the judge's.

The judge then turned her attention to the crucial time to consider the intention of the parties, and stated this was the point when the trust was created.  As she pointed out, Munby J had stressed this, in   A v A [2007] EWHC 99 (Fam), [2007] 2 FLR 467,  when he said as follows:

"Once a trust has been properly constituted, typically by the vesting of the trust property and the trustee(s) and by the execution of the trustee setting out the trust upon which the trust property is to be held by the trustee(s), the property cannot lose its character as trust property save in accordance with the terms of the trust itself, for example, by being paid to applied for the benefit of a beneficiary in accordance with the terms of the trust deed.  Any other application of this trust property is simply and necessarily a breach of trust: nothing less and nothing more".

The preceding point surfaced rather later in the judgment, at paragraphs 243 and 244.  It was at this juncture that the judge dealt with a point advanced on behalf of the wife concerned with the 2014 trust deed; admitted by all parties to be a sham.  It is not possible to improve upon the judge's statement of the point, nor her analysis thereon. The relevant paragraph reads as follows:

Thus, as part of his opening skeleton argument, it was said by Mr Amos on behalf of the wife that, in relation to the (admittedly sham) 2014 Trust Deed, the husband must now be presumed to be fixed by his representation that he was the beneficial owner of the C Limited shares.  As the innocent third party, the wife is entitled to rely on the representation made in the later Trust Deed and he cannot now in this litigation advance a contrary case.  I agree with Mr Warwick [counsel for the Trustee] that this is not a free-standing point of law but rather part of the jurisprudence in relation to the issue of sham transactions.  It is quite clear from the judgment of Munby J in A v A that a trust which is not initially a sham cannot subsequently become a sham.  I have found that the ABC Trust which was set up in August 2007 was not a sham and it therefore seems to me that nothing which was said or done subsequently in 2014 can make it a sham.  The husband could not give away in 2014 that which was not his to give."

All of the foregoing law was carefully applied to the facts of the case by the judge.  In summary, although the judge accepted the wife's evidence, and rejected parts of the husband's evidence, she did not conclude that the ABC Trust was a sham.  Although she was too elegant to use the terminology of the Grand National, she effectively found that the wife had not succeeded in overcoming the various high hurdles, that the law requires to be surmounted, before a finding of sham can be justified.