Leader.co.za

When a Trust is not a Trust: Trading Trusts and Family Trusts under the spotlight

by Walter Geach: Senior Professor and Fellow of the University of KwaZulu-Natal. He is an Advocate of the High Court of South Africa and a Chartered Accountant and Auditor.

A trust is a very useful device. Apart from estate and financial planning uses, a trust can effectively protect assets, and can also be used for business or trading purposes instead of the use of a company or close corporation.

One of the great advantages of a trust is its flexibility and lack of formality in its creation and operation. However, trusts are increasingly coming under scrutiny by the Courts, and there have been a number of decisions that have resulted in many so-called “trusts” being ignored, and the assets of the so-called trust deemed to be personally those of a beneficiary or trustee of that trust. As such they are subject to the claims of creditors, ex-spouses and others. Trading trusts have also been the subject of intense scrutiny by the courts, and the reality of the situation is that many so-called “trading trusts” are not trusts at all, but are regarded as partnerships or the “trustee” or “beneficiary” is treated in law as a sole trader.

In spite of their popularity, many people simply do not understand the nature of a trust or the duties of trustees, nor the rights of beneficiaries. Some people form a trust and then simply treat that trust as their alter ego. They do so at their peril as recent legal judgements have shown.

‘Family’ trusts and trading trusts

One type of trust that is increasingly receiving attention is the so-called ‘family trust’. A family trust is a trust that is designed to secure the interests and protect the property of a group of family members. On the other hand, a ‘trading trust’ is a trust that is established to carry out some venture, business or trade.

The problem with many family and trading trusts is that they are often specifically designed to be controlled by the founder, beneficiaries and/or by their agents for their own benefit. Unashamed control of a trust in this manner can cause the trust to be regarded as a sham or a front, with the consequences that the assets under so-called trust would be regarded as those of the person or persons who control the trust, and the protection and planning opportunities afforded by trust ownership would be lost.

What are the requirements to establish a valid trust?

The legal definition of a ‘trust’ is that a trust is a ‘legal relationship’ which has been created by the founder of the trust through placing assets under the control of another person (trustee/s), during the founder’s lifetime (an inter-vivos trust) or on the founder’s death (a testamentary trust), for the benefit of third persons (the beneficiaries).
From the definition it is apparent that there are three main parties to a trust: the founder, the trustees, and the beneficiaries. Many ‘family trusts’ and many ‘trading trusts’ consist of persons who occupy all three positions. This, in itself, might be sufficient for a trust to be regarded as a sham which will be legally disregarded.

Some of the essential elements for the creation of a valid trust are detailed below. It is important to realise that, if any one of these essentials is not present, then no trust has been created even though the parties may have termed what they created ‘a trust’. Just because something is called ‘a trust’ does not make it such. Similarly, simply because the Master of the High Court has assigned a reference number to ‘a trust’ does not confer any validity or legality on that structure and a person cannot assume that a so-called trust has been validly formed merely because the trust has a Master’s Office reference number.

In order to create a trust the following are some of the more important requirements:

  1. There must be an intention by the founder to create a trust and this intention must be expressed in a way that creates an obligation on the trustee/s.
  2. The trust property must be defined with certainty.
  3. The trust object must be sufficiently certain: the beneficiaries must be clearly defined. A trust without a beneficiary is a nullity.
  4. There should be a separation of those persons who control a trust from those that can benefit from that trust.

Intention to create a trust

There must be a bona fide intention to create ‘a trust’ and not something else.

A trust must therefore have a founder, trustee/s and at least one beneficiary. In the case of a so-called ‘family’ trust, all too often the actual intention is to carry on controlling and owning assets ‘as before’ i.e. the founder’s real intention is to control and enjoy the assets in trust as though they are his/her own property. In the case of ‘business trusts’, all too often the real intention is to create a partnership-type structure, even though it is termed ‘a trust’.

Therefore there are many instances where the parties believe that they have created a trust, but in law they have created something else, such as a partnership, a usufruct, or they may even have transferred property to another without imposing any trust obligation on that person. In some cases (especially when a trust acts as the alter ego of the founder or beneficiary) nothing in fact might have been created: the assets remain or are deemed to be those of the founder and/or the beneficiaries of the trust, depending on the circumstances.

Separation of ownership and control

It is now also clear from recent legal judgements (see for example Land and Agricultural Bank of SA v Parker and Others 2005 (2) SA 77 (SCA)) that one of the key requirements for a valid trust is that there must be a separation of benefits from control and ownership. The trustees are required to administer the assets under their ownership and control for the benefit of the beneficiaries of the trust.

Often however the sole trustees of a trust are also the beneficiaries of that trust. The control of many ‘family trusts’ resides with the beneficiaries of that trust who, in their capacity as trustees, have little or no independent interest in ensuring that transactions are fairly concluded with third parties. In fact, if things go awry, they have every inducement as beneficiaries to deny the trust’s liability or their own.

In the case of companies and close corporations, the Courts have made it clear that even though a company or close corporation is a separate legal entity, a court ‘will not allow a company to justify wrong, protect fraud or defend crime’. If a company or corporation is used for one of these purposes, a court will pierce the corporate veil and hold shareholders and/or directors personally liable for the corporation or company’s debts, wrongdoings or abuses.

In the same way, the Appellate Division has recently made it clear that, in the case of trusts, the courts will ensure, that in appropriate cases, ‘the trust form is not abused’.

If a person has assets, and puts these into ‘trust’ whilst retaining control and having beneficial ownership, the courts have stated that such conduct invites the inference that the trust is a mere cover for the conduct of business ‘as it was before’. In such cases the assets allegedly vesting in trustees in fact belong to one or more of the trustees or beneficiaries in their personal capacity, and so may be used in satisfaction of debts. The trust form is a mere veneer that in justice should be pierced in the interests of creditors. Creditors would include suppliers, SARS and banks.

Conclusions

If a person wants to create a trust with all the advantages and protections afforded by trust ownership of assets, then that person must ensure that the real intention is obvious from all documentation and from the reality of the situation. There must be a majority of independent trustees who are actually consulted about trust matters. Trust assets must not be treated as those of a beneficiary’s.

There ought to be proper trustee meetings with proper minutes. Minute books should be properly maintained and trustee decisions should be properly recorded.

Professor Walter Geach is the author of “Trusts: law and practice” published in October 2007 by Juta and Co Cape Town.


Useful resources:
Graduate School of Business and Leadership, University of KZN
The Graduate School of Business and Leadership is situated on the Westville Campus of the University of KwaZulu-Natal in a natural conservancy and enjoys a sweeping view of the Springfield Business Park and the Indian Ocean. The school’s facilities are modern and offer students some of the latest teaching technologies.
Share on Twitter Share on LinkedIn Share on Facebook
Share via Email
©2024 SURREAL. All rights reserved.
Follow us on Twitter Follow us on LinkedIn Join us on Facebook