Introduction
In the field of equity and trusts law, discretionary trusts represent a flexible mechanism where trustees hold property for the benefit of a class of beneficiaries, exercising discretion over distributions (Hudson, 2015). However, not all purported trusts are valid; some may be deemed sham or illusory, undermining their legal efficacy. This essay explores how to ascertain whether a discretionary trust is genuinely created, distinguishing it from sham or illusory arrangements. Drawing on key legal principles, case law, and scholarly analysis, it outlines the essential elements for validity, methods to identify shams, and indicators of illusoriness. By examining these aspects, the discussion highlights the importance of intention and certainty in trust formation, particularly relevant for students navigating trust law complexities.
Elements of a Valid Discretionary Trust
To determine if a discretionary trust is created, one must first verify compliance with the three certainties: certainty of intention, subject matter, and objects (Knight v Knight [1840] 3 Beav 148). Certainty of intention requires clear evidence that the settlor intended to create a trust, typically through a deed or declaration imposing trustee obligations (Hudson, 2015). For discretionary trusts, this involves granting trustees power to select beneficiaries and allocate benefits, as seen in McPhail v Doulton [1971] AC 424, where the House of Lords upheld a trust for employees and relatives, provided the class was conceptually certain.
Furthermore, the subject matter must be identifiable property, and objects (beneficiaries) must allow trustees to exercise meaningful discretion without rendering the trust void for uncertainty. If these elements are absent, the arrangement fails as a trust. However, even with apparent compliance, deeper scrutiny is needed to ensure it is not a sham or illusory. Generally, courts look for genuine separation of legal and beneficial ownership, with trustees acting independently (Pettit, 2012). This framework provides a baseline for evaluation, though practical application often involves evidential analysis of the settlor’s conduct.
Identifying Sham Trusts
A sham trust exists when the documentation purports to create a trust, but the true intention is to retain control or deceive third parties, such as creditors or tax authorities. To determine this, courts examine whether the parties intended the trust instrument to have legal effect or if it was merely a facade (Snook v London and West Riding Investments Ltd [1967] 2 QB 786). In Rahman v Chase Bank (CI) Trust Co Ltd [1991] JLR 103, the Jersey court invalidated a trust where the settlor continued to treat assets as personal property, indicating no real intention to divest control.
Evidence plays a crucial role; inconsistencies between the trust deed and actual behaviour, such as the settlor directing trustees or accessing funds freely, signal a sham (Hayton et al., 2015). Arguably, this requires a holistic assessment, including contemporaneous documents and witness testimony. Therefore, to confirm a discretionary trust is not a sham, one must verify that trustees exercise genuine discretion without undue settlor influence, ensuring the trust operates as intended rather than as an illusion for ulterior motives.
Distinguishing from Illusory Trusts
Illusory trusts, often overlapping with shams, arise when the trust appears valid but lacks substantive effect, typically due to excessive settlor retention of powers, rendering beneficiary interests meaningless. For instance, if a discretionary trust grants trustees absolute discretion but the settlor reserves veto rights, it may be illusory, as no enforceable obligations exist (Armitage v Nurse [1998] Ch 241). Here, the Court of Appeal affirmed that trustees’ duties persist, but extreme discretion could border on illusoriness if it negates any beneficiary rights.
To differentiate, evaluate whether the trust imposes irreducible core duties on trustees, such as acting in good faith (Hayton et al., 2015). If the arrangement is so vague or controlled that it equates to a bare power rather than a trust, it fails. Typically, this involves analysing the trust deed’s language and the settlor’s post-creation actions. Indeed, while discretionary trusts allow flexibility, they must not be illusory constructs devoid of accountability.
Conclusion
In summary, determining whether a discretionary trust is created and not a sham or illusory requires scrutinising the three certainties, intention, and evidential conduct. Key cases like McPhail v Doulton and Rahman underscore the need for genuine separation of control and meaningful trustee discretion. Implications for trust law include enhanced creditor protection and fiscal integrity, though challenges persist in proving subjective intentions. For students, this highlights the nuanced balance between flexibility and validity in equity, urging careful drafting to avoid invalidation. Ultimately, robust analysis ensures trusts serve their equitable purpose without descending into deception.
References
- Hayton, D., Matthews, P. and Mitchell, C. (2015) Underhill and Hayton: Law Relating to Trusts and Trustees. 19th edn. LexisNexis.
- Hudson, A. (2015) Equity and Trusts. 8th edn. Routledge.
- Pettit, P. (2012) Equity and the Law of Trusts. 12th edn. Oxford University Press.
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