The trust that wasn’t – when a trust’s purpose backfires
The High Court, in a recent judgement, clarified the legal principles concerning sham trusts and the circumstances under which transactions can be set aside under insolvency law.
Facts:
The applicants/claimants (‘the trustees’) are the joint trustees in bankruptcy of Mr. Dixon, the first respondent. Mr Dixon was formerly a Managing Partner and UK Head of Tax for Ernst & Young, earning approximately £2m p.a. in the run-up to his departure. However, he was declared bankrupt on 30 August 2017 on the petition of HMRC in the sum of £627,302.
The trustees brought claims related to six declarations of trust (DoTs) and a loan agreement executed by Mr. Dixon on 9 September 2010, diverting all present and future assets in favour of his wife, Mrs. Dixon, the second respondent. The DoTs and the loan agreement purported to transfer Mr. Dixon's assets, including his capital account and undrawn profits from Ernst & Young, into trust arrangements.
The trustees, however, maintain that the DoTs and the loan agreement are shams. They also argued that the DoTs were transactions at an undervaluation and were made with the specific purpose of putting assets beyond the reach of those who might claim them.
The trustees also seek declarations and other relief in respect of two property transactions entered into by Mr. and Mrs. Dixon, after the DoTs were executed, but before the bankruptcy order. The first was the purchase by Mr. Dixon of a property in Barbados in the name of Mrs. Dixon in November 2014 at an undervaluation. The second relates to a sale on 4 October 2016 of a property in Cambridge, for which the trustees seek a declaration that this was a void disposition, and one-half of the net proceeds of the sale of that property are held by Mrs. Dixon for Mr. Dixon as part of his bankruptcy estate.
Decision:
The High Court ruled in favour of the trustees, noting that all six DoTs were transactions at an undervalue under Section 423 of the Insolvency Act 1986. As a result, ICC Judge Barber granted the declarations sought and ordered that the DoTs be set aside. Regarding the specific properties, for the
Barbados property, the requirements of s.339(3)(a) and s.341(1)(a) are met and, as Mrs. Dixon is an ‘associate’ for the purposes of s.341(2), a presumption of insolvency arises, one which has not been rebutted on the evidence. The trustees have also made out their claims in respect of Mr. Dixon’s 50% share in each of the Argyll and Cambridge properties and the proceeds of sale thereof. Both properties were sold between the date of presentation of the bankruptcy petition and the date of the bankruptcy order.
The Court concluded that the Dixons did not have any genuine intention to create the legal relationships and obligations that the documents purported to create. The evidence suggested that the true purpose of the documents was to create a false impression for third parties, particularly creditors, that Mr. Dixon's assets were held in trust and thereby protected from any future claims. The Court found that Mr. and Mrs. Dixon intended to retain full control and benefit of the assets, despite the legal documents stating otherwise.
The Court's reasoning for setting aside all six DoTs as transactions at an undervalue was based on Section 423 of the Insolvency Act 1986, which requires a subjective test of intent. The Court was satisfied that a "principal purpose" of Mr. Dixon's entering into the DoTs was to put his assets beyond the reach of potential creditors who might make claims against him. The fact that the DoTs were executed after the insolvency of a company with which Mr. Dixon had a relationship, and with the clear intention of moving assets out of his ownership, was a significant factor in establishing this prohibited purpose. The various transfers of assets under the DoTs were made for no consideration, which further supported the claim that they were transactions at an undervaluation.
Implications:
This case is a stark reminder of the importance of genuine intent when creating a trust. The Court found that some of the trusts were "shams" because the parties' actions demonstrated that they never truly intended to part with control of the assets. It is insufficient to simply have a formal trust document, as the actions of the settlor and beneficiaries must be consistent with the terms of the trust. The Court will scrutinise whether the settlor has truly relinquished ownership and control of the assets, as, if the settlor continues to act as the de facto owner, the trust may be found to be a sham.
The judgement clarifies and reinforces the Court's power under the Insolvency Act 1986 to set aside transactions that are deliberately designed to defeat creditors' claims. This case confirms that even if a transaction is not a sham, it can be set aside if it was entered into at an undervaluation to put assets beyond the reach of creditors. The timing of a trust's creation is thus a key factor. If a trust is established when the settlor is aware of a potential claim against them, it is highly likely to be challenged and set aside by the Court. The Court noted that relying on professional advice does not, by itself, negate the "prohibited purpose" of defeating creditors.