The DNA of the modern South African trust is a reflection of the country’s checkered history. A hybrid of English common law, Roman-Dutch civil law, and a sprinkling of distinctively South African principles, the trust was received into our law as essentially an administrative device in terms of which one person (the settlor or founder) “makes over” or alienates her ownership in property to another person (the trustee), who controls and administers the property, or its proceeds, for the benefit of one or more specified persons (the beneficiaries). Through a process of “jurisprudential osmosis,” the shape and form of the modern South African trust has certain features that are fundamental to its legal nature. In particular, the concept of a trust entails the separation of ownership and control of trust property from the enjoyment of the property itself. As the SCA held in Land and Agricultural Bank of South Africa v Parker and Others, 2005 (2) SA 77 (SCA), the “core idea” of the South African trust lies in a functional separation between trustees’ control over the trust property, on the one hand, and trust beneficiaries’ enjoyment of the benefits yielded by that control, on the other. However, because our law allows one and the same person to be both a trustee and a trust beneficiary (provided he or she is not the sole trustee and sole beneficiary), this “core idea” is sometimes disrespected in practice, as when, for example, a trustee who is also a trust beneficiary treats trust property as though it were his own, without regard to the terms of the trust deed or his fiduciary duties to other beneficiaries.
However, there are varying degrees to which the core constituents of the trust form may be disrespected. Not all instances in which a trust is misused necessarily amount to an abuse thereof. Sometimes the facts of a case demonstrate that the very existence of a trust ought to be disregarded, say, because the evidence reveals the trust was established insincerely as a façade to ward off looming creditors; in other cases, the evidence might fall short of demonstrating deceit and prove only that a trust has been maladministered by its trustees in breach of their fiduciary duties to trust beneficiaries. It cannot be stressed enough that identifying which facts give rise to a particular legal remedy and on what basis is crucial to maintaining the integrity of South African trust law and of the trust institution itself. Unfortunately, in recent years, our courts have experienced some difficulty in doing precisely this, resulting in a body of inconsistent case law that has muddied the basic principles applicable to trusts and the remedies available when the conduct of their participants is challenged in court. In this article, we will examine the key differences between three concepts that lie at the heart of the confusion regarding the appropriate treatment of trusts where they are disputed: namely, (i) the sham trust; (ii) the so-called “alter ego” trust; and (iii) the remedy of “going behind” or piercing the veneer of a trust. The point of doing so is to underscore the following: Proving that a trust is a sham or that an abuse of the trust form has been perpetrated such as would justify the court in going behind it are sufficient, self-standing grounds for remedial relief; an “alter ego trust”, on the other hand, is merely a label given to a trust whose affairs are under the exclusive and effective control of some related individual. The alter ego character of a trust, in other words, serves not as an independent cause of action but as evidence of another basis of relief, such as that the trust in question is a sham or has been subject to gross abuse. Once these ideas have been explained, the available relief will be discussed.
To illustrate these concepts, I need to introduce our two fictitious protagonists, Gary and Thando, whose trials and tribulations we will use selfishly for our own explanatory ends.
GARY AND THANDO’S STORY
Gary, a software engineer and avid collector of vintage pinball machines, and Thando, an accountant with an uncharacteristically wicked sense of humour, had been together for over a decade when they decided to tie the knot in a beautiful ceremony in Cape Town. They chose to marry out of community of property subject to the accrual system, which meant that they each retained ownership of their own assets and liabilities but that any increase in the value of their respective estates during the marriage would be divided equally between them on divorce. Everything seemed to be going well for the newlyweds until Thando started acting strangely. Gary couldn’t put his finger on it at first, but eventually he realised that Thando was being unfaithful. The marriage deteriorated rapidly. Despite their best efforts to save the relationship, and after much soul-searching and couple therapy, the pair were unable to repair the damage that had been done. Gary, on the promptings of his sister Mary, who had always been a bit of a sceptic when it came to romance and suspected that Thando’s wit and charm concealed a dark and twisted personality, decided to institute divorce proceedings.
Scenario 1: the sham trust
During the divorce proceedings, it emerged that Gary, unbeknownst to Thando, had established a trust soon after discovering the infidelity. In terms of the trust deed, Gary was the founder and co-trustee of the trust, together with Mary. The sole beneficiary of the trust was one “Mr Baggins,” whom Gary later indicated was “his closest and most loyal friend.” As it transpired, Gary, as the founder, had transferred a number of valuable personal assets to the trust pursuant to s1 of the Trust Property Control Act 57 of 1988 (which requires the founder, in establishing the trust, to transfer ownership in property to the trustee(s)). Strangely, these included many indispensables, such as Gary’s stock portfolio, new BMW 3 Series, and state-of-the-art “Wizard of Oz” pinball machine, none of which Gary owned prior to the marriage. The intended effect of the trust’s creation, as Gary well knew, was to create a separation of estates: the assets, on transfer to the trust, no longer formed part of Gary’s personal estate and, by dint of that fact, were now excluded from the accrual calculation in the upcoming divorce.
But Thando’s attorneys were no fools. Alive to Gary’s stratagem, they sought to establish that the trust concerned was nothing but a “sham” and that its putative existence fell to be disregarded “with the result that the property ostensibly vested in it actually remained the property of the person who had purported to make it over.” The nub of their challenge, which was ultimately successful, was that Gary’s conduct was inconsistent with there ever having been a bona fide intention to give up ownership or control of the assets for the purpose of enabling the guardianship of the property by fiduciaries for the benefit of beneficiaries. For one thing, the trust was established at a time when, as Gary conceded in cross-examination, “the marital discord had reached a climax and the prospect of a divorce cast an imminent shadow.” But, more tellingly and fatally for Gary, it was revealed in court in a shocking twist that Mr Baggins, the sole beneficiary of the trust and Gary’s “closest and most loyal friend,” owed his unflinching loyalty to the fact that he was a fluffy, brown Labrador retriever. Since the law regards animals as the property of their owner, the result was that the trust lacked a beneficiary and was accordingly a nullity on this ground alone.
Let us pause to appreciate the legal principles at play. The example illustrates the concept of a sham trust. Now, the question of whether or not a trust is a sham depends on whether the requirements for the valid creation of a trust have been observed. As the court noted in Van Zyl NO and another v Kaye NO and others, 2014 (4) SA 452 (WCC) para 19, “holding that a trust is a sham is essentially a finding of fact. Inherent in the determination that a trust is a sham must be a finding that the requirements for the establishment of a trust were not met, or the appearance of having met them was in reality a dissimulation.” In our law, these requirements are as follows: (i) the founder must intend to create a trust (which presupposes a bona fide intention to transfer ownership of property to the trustees of the trust to be administered for the benefit of specified beneficiaries); (ii) the founder’s intention must be expressed in a mode appropriate to the creation of an obligation (such as a valid contract); (iii) the trust property must be defined with reasonable certainty; (iv) the trust object must be defined with reasonable certainty; and (v) the trust object must be lawful.
Clearly at issue in the above scenario was the first requirement: as the facts showed, Gary did not intend, truly and sincerely, to relinquish ownership of the property purportedly transferred. The nature of the property, the timing of the trust’s creation, and, of course, the identity of the sole beneficiary showed that Gary’s real intention was to use the name and shape of a trust to gain an undue advantage, namely, to reduce his accrual liability to Thando. What, then, is the effect of finding that a trust is a sham? According to settled principles, where the evidence establishes that a trust is a sham, the assets ostensibly vested in the trust remain the property of the person who purported to make them over and may be attached to satisfy a claim by a third party against that person. This situation is to be distinguished from that where a court finds that the existence of a validly established trust ought nevertheless to be disregarded for a particular purpose in light of the trust form having been abused, as the next example illustrates.
Scenario 2: Piercing the trust veneer and the purely evidential value of the “alter ego” trust
As young, ambitious professionals, Gary and Thando were collectively of substantial means. Kings of the ‘gram and embodying the #couplegoals lifestyle, they enjoyed the high life in a swanky penthouse with floor-to-ceiling windows, spent their weekends at the hottest rooftop bars and exclusive clubs, and sported passports replete with stamps from various extravagant locales. To their friends and colleagues, theirs was a life of enviable glamour and success. Be that as it may, Gary grew weary of his job as a software engineer. His real dream was to turn his lifelong passion for vintage pinball machines and other arcade equipment into a business. When the opportunity presented itself for him to start a company trading in vintage arcade games, Gary jumped at the chance and formed “The Pinball Wizard (Pty) Ltd,” or “TPW,” for short. However, he knew that starting a business carried a certain level of risk and that it would be remiss to expose hard-earned assets, such as their jointly owned penthouse, to creditors’ claims in the event business didn’t go as planned (this was especially so because Gary knew he would have to stand surety for the debts of TPW). For this reason, he suggested to Thando that they transfer ownership of their penthouse to a trust. Thando, who was always supportive of Gary’s dreams, agreed, and the trust was set up, with Gary as sole trustee and co-beneficiary with Thando.
Suffice it to say that all of this was before Gary caught wind of Thando’s amorous disloyalty. After the affair came to light, Gary, filled with anger and resentment, took it upon himself to effect the following proprietary changes to his estate, leveraging the trust as his legal instrument: first, in his capacity as trustee, he entered into an agreement of sale with himself in his personal capacity, in terms of which he sold to the trust various personal (and precious) assets for well below their market value. Second, Gary donated his shareholding in the company, which he had incorporated for his trading business, to the trust. Finally, in his personal capacity, he procured a large loan from the trust, which he approved and granted as sole trustee. The net effect of these transactions was that Gary’s personal estate, once brimming with wealth, was left meagre and saddled with debt. Knowing that when it came time to divide the increase in the value of their respective estates during the marriage (as required by the accrual system), Thando’s share would be significantly decreased, Gary issued a summons against Thando for a decree of divorce.
Thando’s lawyers were quick to act and immediately filed a counterclaim seeking a declaration that Gary had perpetuated an abuse of the trust form. Accordingly, they sought an order that the court pierce the trust veneer so as to render the trust responsible to satisfy Gary’s accrual liability, “consistent with the principle stated in Badenhorst v Badenhorst.” They alleged that the evidence showed Gary had abused the “core idea” of the trust in that he exercised unfettered de facto control over the trust, whose assets he treated as his own. The result, Thando’s lawyers argued, was that the trust was nothing other than Gary’s “alter ego,” which thereby enabled him to conduct the affairs of the trust with the explicit object of defeating Thando’s patrimonial claim.
After hearing all the evidence, the court held that the pleaded case justified an order piercing the trust veneer. In this regard, it ordered that the discounted assets sold, and shareholding donated to the trust be made available to settle Gary’s accrual liability. As for the loan, the court held that it was “mere financial sleight-of-hand, a disingenuous cooking of the books,” and held that no debt was genuinely incurred by Gary’s estate. However, in reaching these conclusions, the court, albeit sympathetic to Thando’s case, commented on the “alarming in exactitude” of certain propositions advanced by his legal team. For clarity’s sake, the court therefore cautioned that practitioners should develop an acute appreciation and understanding of the differences between the following principles, as recently clarified by the SCA.
These can be summarised as follows:
- The general rule is that if a trust has been properly formed (i.e. it is a valid trust and not a sham), then none of the trust assets may be made available to satisfy a claim by a third party, including an accrual claim, since the assets will continue to be uninterruptedly held in trust;
- The remedy of “going behind the trust” or “piercing the trust veneer” is founded in common law is available where the trust form has been abused. It entails “accepting that the trust exists but disregarding for given purposes the ordinary consequences of its existence” (Kaye, para 21). If a trust’s veneer is pierced, then trust assets may indeed be made available – that is, attached – to satisfy a claim against a related person, such as an errant trustee;
- However, whether or not there has been an abuse of the trust form depends on whether “the trust form has been used in a dishonest or unconscionable manner to evade a liability or avoid an obligation” (Kaye, para 22);
- The fact that a person, whether trustee, beneficiary, or founder, exercises control over a trust to such a degree as to give rise to the trust being labelled that person’s “alter ego” does not, in itself, entail an abuse of the trust form. Thando’s allegation that Gary had abused the “core idea” of the trust owing to his unfettered control thereof was therefore misconceived. Rather, the relevance of the alter ego character of a trust is purely evidentiary: it affords no independent cause for proprietary relief but only calls attention to the likelihood that the exercise of such unfettered control may be serving to defeat another party’s right or claim against the controller;
- Likewise, absent a fraudulent, dishonest, or unconscionable use of a trust to defeat a right or evade a liability, the fact that a trustee administers a trust with scant regard for “the essential dichotomy of control and enjoyment” – the “core idea” of the trust – is no legal basis for a court going behind the trust (Mills v Mills, 2017 (3) SA 371 (SCA)). That said, such maladministration may well justify her removal as trustee;
- Finally, as the SCA recently confirmed in MJK v II K [2022] ZASCA 116 (28 July 2022), the approach in Badenhorst did not entail piercing the trust veneer or holding that the trust was a sham, contrary to Thando’s allegation. In Badenhorst, the court was faced, not with an accrual claim, but with an application for a redistribution order in terms of s7(3) of the Divorce Act. The court held that s7(3) afforded it (the court) a discretion to treat the value of the trust’s assets as if it was value in Mr Badenhorst’s personal estate when determining the amount that he should have to pay, from his own pocket to his wife upon their divorce. While s7(3) empowers the court to “have regard” to the value of trust assets in determining what is a just and equitable monetary payment for redistributive purposes, it does not allow resort to execution against the trust assets themselves. To this extent, the trust remains intact.
Conclusion
Though fictional, Gary and Thando’s tumultuous tale of love and litigation was premised on real cases that have been brought before our courts. Yet, until very recently, even the courts misunderstood the key distinctions between sham trusts, the remedy of piercing the trust veneer, and the more circumscribed role of the so-called “alter ego trust.” This is especially so in the matrimonial context, where the courts have overlooked the proper ambit and statutory framework of the decision in Badenhorst. Fortunately, the law in this area is starting to morph into to a more settled shape. Briefly summarised, it can be said that:
- Sham trusts do not have legal status, and the assets purportedly made over are therefore not protected through the trust vehicle;
- Trusts that are abused remain valid legal vehicles, but the courts may “pierce the veneer” to the extent of the abuse, and the affected asset or transaction will lose protection;
- Alter-ego trusts are not a species of legally recognised trust in our law; rather, “alter ego” is simply a descriptor that the beneficiary/trustee has unchecked control of the trust, a situation which frequently leads to abuse; and
- The value of assets in so-called “alter-ego” trusts may be treated as value in the personal estate of the controlling spouse when a court is asked to determine the value of an equitable redistribution in terms of s7(3) of the Divorce Act.
Given that trust law can be complex, it is prudent for practitioners and laypeople alike, not least those intending to set up their own trusts, to develop a clearer understanding of the subtle but important differences between these principles. After all, ignorance of the law is no excuse.
B Soc Sc LLB
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B Com LLB
B Soc Sc Hons (Psych) LLB
B Com LLB
