Trusts are invariably used by individuals and entities to conceal who the true owner of the property is and is usually asserted by the trustee or the beneficiary when a creditor is seeking to use the assets that is under the ownership of trustee to satisfy the trustee’s liabilities.
A commonplace wherein the trusteeship device is used is when the true owner is seeking to protect real property. A trustee through a bare trustee agreement will hold the property in trust for the beneficiary.
One of the main benefits of this approach is the trust will not be captured by the Bankruptcy and Insolvency Act as prescripted by section 67(1)(a). As this section, generally, will exclude properties that are held in trust that would otherwise vest with the trustee for the benefit of the creditors.
In the decision of McGoey (Re), 2019 ONSC 80 Penny J. enunciated the principles used to determine whether a trust is sham.
The procedural backdrop of this decision is the trustee of the bankrupt’s estate sought a declaration that the bankrupt’s interest in properties which he held in joint tenancy with his wife, were assets of the estate subject to realization for the benefit of the creditors.
The bankrupt was a senior executive who was subsequently sued by the company for breach of fiduciary duty and restitution of the entire compensation received by him.
Following a trial, the bankrupt was ordered to pay approximately $5.5 million to the company.
The bankrupt filed a notice of intention to make a proposal under the BIA. The proposal was rejected, and the bankrupt was assigned to bankruptcy.
The trustee in bankruptcy sought to realize on bankrupt’s real properties which are held by the bankrupt and his wife (which are held in joint tenancy) in trust for their children.
The Court surveyed the trust documents for the properties that were purportedly held in trust. The trust documents were not professionally drafted. But they were purportedly drafted years before the bankrupt’s malfeasance as a senior manager which led to the bankrupt’s financial issues.
The Court in its analysis first started with describing what a sham is. The Court:
held a sham is a transaction or instrument designed to give the appearance of creating legal rights or obligations that are different from what the party actually intended to create. In the context of a trust, a sham trust is usually created for a fraudulent, deceitful or illegal purpose, such as avoiding a creditor. However, deceit is not a necessary element of a sham trust, The trust need only be presented by the parties as being different from what they know it to be, Sangha v. Reliance Investment Corp Ltd, 2011 BCSC 1324 at paras 346 - 347.
The Court further held the trust being held as invalid depends on the intention that existed at the time trust was made. Specifically, whether the settlor “did not intend to part with the beneficial interest in [the] trust property…” and the trust document suggests otherwise from that intention. If there is not clear and cogent evidence of an intention to create a valid trust, a trust can be set aside as a sham.
To put this analysis in the context of the three legal requirements to create a trust (the three certainties). The certainty of intention being one of the certainties that must be met, would be missing if the evidence proves there was no intention.
Court’s Application of the Law
Interestingly enough, the trustee retained a typography expert to provide evidence the trust documents could not have been drafted in the year the bankrupt alleges. It must have been drafted 12 years later, which was around the time the bankrupt was facing financial ruin.
The expert came to this conclusion based on the fact the font used in the trust document did not exist in the year the bankrupt alleges he drafted the trust documents.
The Court held the bankrupt had no evidence to dispute this. The Court accepted the expert’s evidence.
In addition to this, the Court held there were “red flags” surrounding the purchase, financing and use of the properties that suggest there was no intention to create a trust. The Court found there was no disclosure of the trust to the mortgagees, no trust registered on title, the funds that derived from the mortgage mingled with the bankrupt’s personal bank account. There was never a tax filing except for in 2017, which was long after the bankrupt’s financial troubles crystallized.
The bankrupt’s wife further admitted one of the reasons for this trust was to protect the asset from potential creditors.
The Court ultimately concluded the trust was a sham. The properties were used, encumbered without disclosing the true owners. All the trusts do is to put the assets out of the reach of bankrupt’s creditors.