News

A decision from the Ontario Superior Court (‘OSC’) provides a useful summary of the common law ‘red flags’ which help creditors and insolvency practitioners identify when a bankrupt’s assets are held in a sham trust. Of interest was the expert evidence showing a font used in a trust document was not invented until seven years after the document was supposed to have been created.

Who questioned the trust?
The trustee (‘Trustee’) of the bankrupt estate of Mr McGoey (‘M’) asked the Ontario Superior Court for a declaration that M’s interest in two properties were assets of his estate and could be realised to benefit his creditors. Mr & Mrs M contended that the title to the two properties was held in two separate trusts for their children and could not be made available to creditors. The Trustees argued that the trusts under which M and his wife held the properties were a sham, or fraudulent preferences created to defeat M’s creditors.

What is a sham trust?
A sham trust is usually created for a fraudulent, deceitful or illegal purpose, such as avoiding a creditor. Where the trust documents appear to create legal rights or obligations which differ from those the parties actually intended at the time the alleged trust was made then it will be a sham.

Why is the Settlor’s intention important?
Three certainties are necessary to establish a trust has been validly created. These are:

1.  Intention: the creator of the trust (‘Settlor’) clearly intended to create a trust;
2.  Subject Matter: it must be clear what assets the trust will hold;
3.  Objects: it must be clear who will be the beneficiaries of the trust.

Where a Settlor intends that the trust will make it look to outsiders that assets have been placed into a trust, then the Settlor lacks a true intention to create a trust and the trust fails. Without clear and cogent evidence that the Settlor intended to create a valid trust, a trust may be set aside as a sham.

How can a trustee show a trust is a sham?
Common law jurisdictions have developed a non-exhaustive list of red flags (or ‘badges of fraud’) which may make a Court investigating the trust ask the party which claims that a trust exists to explain. For real property these include the Settlor(s):

i.     listing a property for sale without disclosing the existence of the trust;
ii.    failing to notify a bank or mortgagee as to the existence of the trust and its effect on 
       title;
iii.   operating in a manner which disregards the proper operation of the trust;
iv.   treating a property as their own and only invoking the alleged trust when convenient to
      do so;
v.    using a property to secure financing (particularly where the trust is not disclosed);
vi.   the payment of all expenses for property by the settlor, while the alleged beneficiaries
      contribute nothing;
vii.  retaining personal control of an asset for one’s own use;
viii. encumbering an asset by using it as security for personal finances;
ix.   not registering a trust agreement on title;
x.    a general lack of documentation; and
xi.   transactions at less than market value, made in the face of a hazardous undertaking or
       clear financial jeopardy.

What red flags did they find?
As well as expert evidence (see below) the OSC found that Mr & Mrs M used the properties as they wished, encumbered them at will (without disclosing the alleged beneficiaries’ interests) and described themselves as the owners in legal documents. It found in all of the circumstances the evidence overwhelmingly supported the conclusion that the two alleged trusts were shams. The only apparent purpose of the trusts was to protect the assets from creditors.

What was the expert evidence?
A graphic arts expert with over 20 years of experience in the font industry gave evidence found to be admissible by the OSC, that one trust document dated January 4, 1995 used a typeface set in a font called Cambria not invented until 2002 and which did not reach the general public until 2007. Another trust document dated 4 March 2004 used a font, Calibri, which whilst it was developed in 2002, it did not reach the general public until 2007. The document used ‘tabular lining’ numbers which were not part of the Calibri default until November 2005. The evidence was used by the OSC to decide that the alleged trust documents did not exist on, and were not signed on, the dates indicated and that they could not have come into existence until 2007 at the earliest.