With estate planning becoming more sophisticated more and more trusts are being established. Simultaneously divorces are increasing by around 8.6% per year, escalating the probability of a trust being involved in the case of divorce or distribution of estates. If a trust is legally established and correctly managed and administered its assets will fall outside the estates of the respective parties. However it often occurs that trusts are in fact not managed and administered correctly. The mistake that occurs most often in the context of divorces, is that the requirement that the trust assets be kept, owned and administrated separate from the trustees’ personal assets (in their capacity as trustee) so as to be regarded and legally acknowledged as assets of the trust (and not as part of the estate of the founder or trustees) is not met. In various court cases it has been decided that the founder and/or trustees did not have the real intention of a trust, namely to keep and manage assets separate from their own estates on behalf of the trust beneficiaries, but instead had the intention to for example keep the assets outside of their estate in order to elude creditors, including spousal claims arising from, for example, the spouse’s matrimonial property system. In these cases the courts looked through the trust as if legally it didn’t even exist.
In above instances where the courts effectively did not legally acknowledge the existence of the trust and did not give consequence to the trust, the trustees typically managed the trust in such a way that it was nothing other than an ‘alter ego’ of the founder or trustee. In such instance no real distinction is made between the trustee’s personal assets and the trust assets, and everything is managed as though it’s the trustee’s personal estate (or assets). The trustee would then for example use the trust assets for his own, unilateral benefit, just as he would have if it were his own assets.
This is in conflict with the principles of a trust which requires that the trustee ought to clearly distinguish between assets kept in his own, personal capacity, and assets kept in his capacity as trustee – and that they should also be clearly kept and managed separately. If that is not done, the trust will lose its independence and consequently be regarded as a ‘sham’ trust. While the fact of each case must be considered separately, characteristics such as the following will typically be found in case of a sham trust:
1. The trust is established or assets are transferred to the trust with the specific purpose of cheating or prejudicing a spouse, especially in order to avoid the legal workings of their particular matrimonial property system.
2. The purpose of the trust is vague, indeterminable or unlawful/illegal.
3. The trust assets are not kept or managed independently from the personal estate of the trustee or donor, with the result that the trust does not really function separately.
4. The de facto management and administration of the trust assets are handled as if it still forms part of the trustee/founder’s personal estate.
5. The founder did not really have the intention to establish a trust on behalf of the beneficiaries, but rather to keep assets outside of his estate in order to, for example, avoid the legal consequences of the matrimonial property system in terms of which he/she is married.
6. In terms of the trust deed the donor has the sole right to replace his co-trustee(s) or change beneficiaries.
Whether a court will regard a trust as a sham trust will depend on the facts, but if so the assets of the trust will be handled on the basis as if there had been no trust, and consequently it can merely be regarded as part of the founder or trustee’s assets or estate. In such a case the court effectively denies the existence of a trust and will the assets not be acknowledged as trust assets, but merely as part of the personal estate of one or both spouses. Such assets will then also be taken into consideration at the distribution of estates in terms of the relevant matrimonial property system applicable to the spouses’ marriage.
It is extremely important though that a declaratory order be sought by the plaintiff to have the trust declared as a sham trust before the divorce proceedings takes place, so that the assets of such trust can be taken into account at the distribution of the respective parties’ estates. The reason for this is that these are two completely different legal proceedings.
Just as a court can issue a declaratory order that declares a trust as a sham trust, there are also various arguments to be raised in favor of a decision that a trust is not a sham trust. These arguments will typically deal with the intention of the trust, namely that the trust was established to for example protect the children, and will center around the fact that the assets in fact has to be acknowledged as trust assets, separate from the spouses’ personal estates, and therefore does not form part of the estates which in terms of the matrimonial property system has to be divided in the event of divorce.
It is rather common for both spouses to also be trustees of a family trust. In such a case, especially where the plaintiff has acted as a trustee of the trust for quite some time before divorce proceedings began, the burden of proof to have the particular trust be declared a sham trust (in order to have the assets declared as part of the other or both spouses’ estates) will possibly be hard to prove.
The Divorce Act 70 of 1979 and the Matrimonial Property Act 88 of 1984
An erstwhile amendment to the Divorce Act grants the court the authority to redivide assets between spouses with regards to marriages out of community of property which were established before November 1984, seeing as they did not have the opportunity to make accrual of property applicable to their marriages (Act 88 of 1984 first brought accrual of property in).
In execution of the Divorce Act courts have made various orders towards the redistribution of estates. While courts won’t generally exercise their discretion to order a division of more than 50% (this is the way in which the interpretation of the Divorce Act developed from court judgments, though the court does have a clear discretion in terms of the Act), courts have in some instances ordered heavier divisions, or for example increased the maintenance load if the court was of the view that one party has effective control over various trust assets. In other words, while the court does not have the authority to order the trustees to allocate their trust assets to a spouse (that is in cases where the existence of a trust had not been challenged, by one of the spouses as discussed above), a court can make a ‘penalizing’ division or maintenance order wherein the court effectively also brought the trust assets in calculation in the making of such an order.
Spouses or prospective spouses must remember that trust assets in principle fall outside the spouses’ personal estates, and therefore won’t be taken into account in case of divorce when it comes to the division of the spouses’ estates with regards to their matrimonial property system.
A spouse would be able to approach a court, with a separate lawsuit, to have a trust declared as an ‘alter ego’ or ‘sham trust’, which would effectively entail that the trust would not be legally acknowledged, as indicated in the cases above.
In addition the Divorce Act grants a discretion to courts to redistribute the assets in the case of divorce of a marriage concluded out of community of property before 1 November 1984. In such cases, a court can grant a more penalizing division- or maintenance order than it would normally do, if the court is of the view that one spouse is in control of significantly more trust assets. Take note that the court does not grant an order towards the division of trust assets, but takes it into account when the division order is made.
It’s therefore important that prospective spouses timeously gather the necessary legal advice to eliminate or limit the future abuse of trusts and the application thereof on their chosen matrimonial property system.