An inter vivos trust (such as a family trust) is created when an individual (called the settlor) transfers property to a trustee to be held for the benefit of the beneficiaries of the trust. After the property is transferred to the trust, the settlor no longer owns the property and on death, the property will not form part of the settlor’s estate. This also applies to the extent that any additional property is transferred to the trust after the trust is settled (from the settlor or another contributor). There are several indirect benefits for the settlor (or contributor) that flow from this. Since the trust property is outside of the settlor’s estate, the assets are not subject to the probate regime or to a wills variation claim under the Wills, Estates and Succession Act. The trust structure may also result in overall tax savings if any income or gain on the trust property can be taxed in the hands of beneficiaries with a lower marginal tax rate than the settlor.
Because of this, trusts are often targets for creditors and disinherited family members who may have had a claim to the settlor’s assets had those assets remained part of the settlor’s estate. Those looking to challenge trusts may seek to invalidate the trust by arguing that the trust was not properly constituted and therefore never came into existence. It is important for anyone involved in setting up a trust to be familiar with these arguments in order to reduce the risk of the trust’s validity being questioned.
The Three Certainties
For an inter vivos trust to be valid, three certainties must be met:
- Certainty of Subject: the trust instrument must clearly describe the property which is to be subject to the terms of the trust, and the nature of the interest due to each beneficiary must be clear.
- Certainty of Object: It must be clear who the trust is intended to benefit. This is fairly straightforward when individual beneficiaries are named in the trust instrument, but where a class of beneficiaries is named, additional care must be taken to ensure the identity of the beneficiaries can be ascertained. For example, classes such as “children” or “nieces and nephews” should be sufficiently certain, but classes such as “close friends” or “family” may not be.
- Certainty of Intention: In transferring the assets, the settlor must clearly intend for the assets to be held in trust for the benefit of the beneficiaries. Determining certainty of intention requires a contextual approach: both the words of the trust instrument and the actions of the parties and surrounding circumstances must be examined. The arguments discussed below (undue influence, sham, and testamentary disposition) are also based on the requirement that there be sufficient intention to create a trust.
Transfer of Property
In addition to the above certainties, as a trust is a means of holding property, there must be a transfer of property to the trust to effectively constitute the trust. What is required here will depend on the nature of the asset being transferred, but there must be effective legal conveyance of ownership and acknowledgment by the trustee of receipt.
If the trust was executed under the undue influence of another person, it does not reflect the true intention of the settlor to create the trust, and the trust will therefore fail. Undue influence will be found where another person places power over the settlor such that the settlor is not acting freely and is not making independent decisions about what to do with his or her property. Where there is potential for domination, undue influence will be presumed at law.
Even if the trust documents provide evidence of intention, it may be argued that the trust is a “sham” if the documents are not consistent with the true intentions of the parties. If a trust is a sham, the provisions of the trust instrument create a false impression with respect to the terms on which the trustee is to hold the trust assets. The settlor wants to appear as having disposed of the assets (for example, to defeat the claims of creditors or family members) but the settlor’s true intention is to continue to own and retain control over the assets.
Another argument against a trust’s validity is that the trust ought to be set aside on the basis that it was, in substance, a testamentary instrument. If this is the case, the trust will fail if it does not meet the requirements for valid execution of a will under the Wills, Estates and Succession Act (unless it is otherwise declared valid by a court order). Whether a trust is inter vivos or testamentary depends on the intention of the settlor. If the settlor intends that it should only take effect on his or her death and it is dependent upon death for its vigour and effect, it is testamentary.
If any of the above arguments is successful, then the trust, and any transfers of property by the settlor (or contributor) to the trustee on behalf of the trust, may be invalid. As a result, the property will continue to be owned by the settlor or contributor (or their estate) and subject to any claims made against them.
In order to ensure a trust is properly constituted, it is important that all formalities are followed when a trust is first set up. Below are some practical tips to keep in mind when setting up a trust:
- Ensure all formalities with respect to the execution of trust documents (and if applicable, testamentary instruments) are followed.
- Ensure the settlor transfers the initial settlement property of the trust to the trustee at the same time that the documents establishing the trust are executed.
- The initial settlement property should be property owned by the settlor, and should be accurately described in the trust deed. The same applies if any additional property is transferred to the trust at a later point.
- The settlor must not be reimbursed for the initial settlement property in any way.
- The trust deed must clearly describe the property subject to the trust, the beneficiaries of the trust and other key terms of the trust.
- Ensure that the settlor understands the terms of the trust deed and the effect of transferring property to the trustee.
- Choose the trustee carefully to ensure they have the proper expertise and experience to administer the trust property.
- Extra consideration should be given in cases where the settlor reserves any powers or retains any control over the trust property.