You would like to protect your assets by putting them in a trust but you would also like to keep control over the assets. The latter desire may look natural because these are your assets, after all. However, if you retain control over the assets kept in trust, a court of law may well decide that yours is a sham trust.
We are not talking about revocable trusts here. A revocable trust can serve some other purposes very well but not the purpose of protecting your assets: the assets legally remain in your possession and therefore, they can be expropriated. We are talking about trusts that are irrevocable on paper but in reality, the Settlor retains full control over the assets in trust.
If a trust is declared a sham trust by a law court, its assets become available to third parties. It is also important to note that many countries do not treat irrevocable trusts established in foreign countries as controlled foreign companies. If you have such a trust and it is deemed sham, it automatically becomes a controlled foreign company and you may face serious fiscal consequences too.
An asset put in trust cannot be arrested unless the trust has been created for fraudulent purposes. For example, if you are on the verge of bankruptcy you may want to put your house in a trust in an attempt to save it. If you keep living in the house, if you don’t pay any rent for that, if you cannot name any other trust beneficiaries apart from yourself, it is going to be clear for the judge that you have put the house in a trust with the only purpose of avoiding losing it to your creditors. Thus, yours is a sham trust and you will have to sell the house to pay back as much as you can to your creditors.
Below we discuss the properties of a legitimate trust, the properties that you would have to demonstrate if a creditor pretends that yours is a sham trust. Before we go on, however, we would like to note that you might want to consider the opportunity of establishing an Endowment in Serbia as an alternative to an irrevocable trust. Serbian Endowments are preferable to trusts in some respects.
Criteria of trust legitimacy
Your trust has to meet certain criteria to be deemed legitimate. If your opponent insinuates that your trust fails to meet one or several of these criteria, the evidence will have to be conclusive and we will discuss this issue too.
Integrity of intent
Both parties (the Settlor and the Trustee) have to demonstrate integrity when creating the trust. If their true goals do not coincide with the goals specified in the Deed of Trust, the trust may be deemed illegitimate.
Sometimes the Settlor may have an ‘unexpressed’ desire to retain full control over the assets in trust. If the Trustee follows the Settlor’s orders without fail, the trust may be deemed illegitimate. However, if the Trustee refuses to act on the Settlor’s orders, the trust remains legitimate. If the judge sees that the Trustee has been acting in an honest way and in accordance with the business rules, he/ she is not going to declare it a sham trust. On the other hand, if the Trustee acts irresponsibly and plays only a nominal role while the Settlor manages the assets in trust, it is a sham trust.
Sufficiency of evidence
Courts of law consider not only trust documents but also the factual state of things. They want to determine the level of separation of property from its owner.
If the Settlor takes an active part in asset management never allowing the Trustee to make the final decision, for the judge, this means that the assets have not been actually separated from their owner: they have remained his/ her property.
On the other hand, if the Trustee fulfills all the requests of the Settlor, this cannot serve as sufficient evidence of illegitimacy of the trust in itself. Answers to the following questions have to be found:
- Has the Settlor made investment decisions without the Trustee’s consent?
- Has the Settlor hired consultants without the Trustee’s consent?
- Has the Settlor used the trust’s bank account without informing the Trustee?
- Has the Settlor exchanged letters with the bank/ financial consultant/ other parties without informing the Trustee?
- Has the Settlor treated the property in trust as his/ her own property in the letters sent to third parties?
- Has the Settlor revoked any decisions made by the Trustee while those decisions should have been irrevocable?
If the Trustee does everything that the Settlor says, it is a sign of their failure to fulfill their fiduciary obligations in good faith. It is not a sign of a sham trust yet.
Summarizing the above, we can say:
- That the key criterion of trust legitimacy is integrity of intent;
- The integrity of intent has to be demonstrated by the Settlor and the Trustee;
- When considering the case, the judges not only review the trust documents but also investigate the factual side of things (trust property management methods, involvement of the Trustee in decision-making, etc.);
- The fact that the parties deviate from the original provisions of the trust deed does not show that it’s a sham trust: such deviations may be considered possible in the trust documents.
How to protect yourself from false accusations
How can you protect yourself if somebody claims that your trust is illegitimate? Every situation is unique, of course but there are a few key points that we can point out. If your trust meets the following criteria, it can hardly be deemed illegitimate:
- First of all, the trust documents have to contain a clear and unambiguous intention of the Settlor to create a trust and put assets there;
- All the action that the Settlor, the Trustee, and The Beneficiary (Beneficiaries) take has to be in conformity with the reasons why the trust has been created. This concerns the instructions to the Trustee and the treatment of the beneficiaries;
- The trust Settlor must know what he/ she is doing when creating a trust. He/ she should not sign the Trust Deed if he/ she cannot make head or tail of what the document (written in the legal language) says;
- The trust Beneficiaries should not ‘leave their fingerprints’ on such documents as investment agreements that the trust makes, agreements with realtors, and so on;
- Any document signed by the Trustee on behalf of the trust should have a clear fiduciary character. It has to show that the Trustee is acting in the interest of the trust and the trust Beneficiaries or trust goals.
If the matter is taken to court, any of these criteria can turn out the key one. Practice shows that the price of risk may be too high so you’d better take care of every item.