Beware of the alter ego trust


Summary

All too often trustees of family trusts, many times dishonestly but also frequently ignorantly, treat the property of the family trust as if it is their own personal property and use the trust essentially as their alter ego, to the detriment of the legitimate beneficiaries of that trust.

Introduction

Family trusts offer multiple longer-term benefits for families planning to preserve hard-earned wealth for the benefit of future generations. Family office structures that incorporate trusts can preserve the vision and legacy of the founder for many generations. However, the fact that a trust deed was officially registered at the Master of the High Court and a Letter of Authority was issued to trustees does not provide an absolute guarantee that trust assets will be safe from attack from creditors or during divorce proceedings.

What is an alter ego trust?

An alter ego trust is one where a person deals with trust assets as if they are their own. It is all too often that trustees of family trusts, many times dishonestly but also frequently ignorantly, treat the property of the trust as if it is their own personal property. A trust can be at risk of being classified as an alter ego trust even if all the necessary requirements for a valid trust are present and the trust is properly established.

An alter ego trust should not be confused with a sham trust. A trust is a sham when some or all the requirements for its creation were not met, and such a trust never legally came into existence.

When is a trust at risk of being classified as an alter ego?

Acts that could indicate that a trust is administered as an alter ego trust include any action where a trustee or founder deals with trust assets as if it is owned by her/him instead of the trust. It is particularly careless for any trustee to make solo decisions and to ignore the general rule that trustees must decide on matters together. Where a trustee acts with trust assets in a manner that indicates that he/she aims to achieve financial gains exclusively for themselves personally, and ignores the beneficiaries as defined in the trust deed, the trust is at great risk of being classified an alter ego of that decision maker.

Alter ego trusts can exist unchallenged for many years and can create a sense of complacency in founders and trustees. Such a situation can invite an ever-increasingly relaxed attitude towards trust assets, until this is eventually challenged in court by the revenue services, a creditor or as part of divorce proceedings.

Consequences of an alter ego trust

In a remedy similar to the ‘piercing of the corporate veil’ in the case of companies, courts can go through the trust form as an equitable remedy to a third party affected by the alter ego trust.

A professional independent trustee is key

It is particularly easy for founders or trustees to deal with trust assets as if they are her/his own when the trust does not use the services of an independent trustee that acts with the necessary care, diligence and skill expected of such a person in terms of the Trust Property Control Act 57 of 1988.

A recent South African court case resulted in the Supreme Court of Appeal instructing the Master of the High Court to insist on the appointment of an independent trustee where the trust is registered for the first time with the Master, and it emerged from the trust deed that the trust is a ‘family business trust’. The purpose of the instruction was to ensure that the trust functions properly and that the provisions of the trust deed are observed. The independent trustee must be suitably competent to scrutinise and check the conduct of any other trustees who may lack a sufficiently independent interest in the observance of substantive and procedural requirements arising from the trust instrument.

Conclusion

When a court rules that a trust is an alter ego of another person, the court can pierce the ‘trust veil’ and make an order that is just and equitable to affected third parties to the detriment of the legitimate beneficiaries of that trust. It is critically important that families ensure that trusts are structured and managed as a separate entity to the founder, any trustee, and its beneficiaries, to ensure that the trust achieves the objects defined in the trust deed.



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