In trusts we trust

trusts 3As parties to litigation, creditors often find themselves in a predicament where the individual they have a claim against has assets of insignificant value. The same individual may, however, be a trustee of a discretionary trust owning substantial assets. Faced with this difficulty, creditors are left with little choice but to ask a court to ‘go behind the trust’ in an attempt to find assets to execute judgment against.

Allegations of a trust being a debtor’s ‘alter ego’ or ‘a sham’ often find their way into pleadings and the terms are frequently used interchangeably.

To date, our courts have mostly shied away from declaring assets registered in a trust to be regarded as assets falling within the personal estate of one of the trust’s trustees. The recent judgment of Van Zyl and Another Nno V Kaye No and Others 2014 (4) Sa 452 (WCC) confirms this reluctance.

In the Van Zyl case, Binns-Ward J had to determine whether two immovable properties, one registered in the name of a trust and the other in the name of a company, should be treated as assets in the insolvent estate of the debtor, Mr Kaye.

Kaye, his wife and an attorney were the trustees of a family trust. The trust owned a property which was used by Kaye and his family as their home. The beneficiaries of the trust were Kaye, his wife and their descendants. Evidence was also led – in a separate enquiry relating to the company Kaye was associated with – which suggested that financial transactions were recorded in the books of various entities over which Kaye exercised control in a manner that did not accurately represent the flow of funds.

The court clarified the difference between finding that a trust is a sham and going behind a trust. To hold that the trust was a sham, in other words non-existent, is a finding of fact, among other things, on the basis that the requirements for the establishment of the trust were not met, in which event the ‘trustees’ of the trust acted as agents of Kaye when acquiring the property.

The court found that even a delinquent discharge by trustees of their responsibilities, resulting in only one trustee exercising unfettered de facto control over the trust assets or the maladministration of an asset of the trust is not enough to justify a finding that a trust is a sham; in other words, a finding that renders the trust non-existent and the asset no longer vesting in the trust. All that this type of conduct does is call into question the fitness of the trustees to hold office.

Going behind the trust, on the other hand, entails accepting the trust’s existence, but disregarding for given purposes the ordinary consequences of its existence. The court found that this may entail holding the trustees personally liable for an obligation undertaken in their capacity as trustees. Conversely, going behind the trust may require holding the trust bound to transactions seemingly undertaken by the trustees acting outside the limits of their authority or legal capacity; or in cases where the trustees treat the property of the trust as if it were their personal property and use the trust essentially as their alter ego. This equitable remedy will generally be given when the trust is used in a dishonest or unconscionable manner to evade a liability or avoid an obligation, rather than in a situation where a creditor seeks relief against a debtor who is a trustee of a trust.

The court pronounced that there is nothing untoward in trusts being established for the purposes of holding family homes separately. Similarly, there is nothing sinister about a trustee personally paying the mortgage bond and maintenance expenses in respect of such a property.

The court went on to find that even if it were accepted that Kaye administered the trust without proper regard to his fiduciary duties and, in a sense, treated the trust as his ‘alter ego’, that does not, in itself, make the trust a sham, nor does it vest ownership of the trust’s assets in the trustees of Kaye’s insolvent estate.

This judgment appears to be another nail in the coffin of creditors who attempt to recover debts from debtors who registered all ‘their’ assets in trusts.

As this avenue of relief narrows, it is important that transacting parties ensure they have sufficient security in respect of debts due to them, in the form of suretyships or security bonds.

Dispute Resolution Matters – 20 May 2015 (126KB)