The importance of relinquishing control for the valid formation of a trust

Introduction

A validly formed trust enjoys many benefits such as asset protection, asset preservation, and tax mitigation opportunities in estate planning. However, in order to validly form a trust, one must have the intention to do so by relinquishing control over the assets which form trust property, otherwise, the court may deem the arrangement a sham thereby forfeiting, from the arrangement’s inception, all the benefits that would apply to a trust. 

This article explains the concept of relinquishing control over trust assets and why this is one of the most important requirements in the formation of a valid trust. 

A trust is an agreement to relinquish control

A trust is established by way of a trust deed, which, conceptually, could be understood as a contract between the founder, the trustee(s), and the beneficiary. It is an agreement whereby the founder must relinquish unfettered control and may relinquish ownership of property, and hands it over to another person, the trustee, to administer for the benefit of those named or identified in the trust deed, the beneficiaries, which may include the founder in his capacity as a beneficiary. What is clear from this explanation is the following: 

1. The founder loses unfettered control over the property;
2. By losing unfettered control over the property, the founder loses the ability to control, at will, the  benefits that flow from the property;
3. The founder may maintain ownership of the property but only in his capacity as a beneficiary of the trust; and
4. The beneficiaries must be identified or named.

If the founder loses both control and ownership of property this is called a discretionary trust where the trustees in their fiduciary capacities will own and control the assets for the benefit of the beneficiaries, whereas if the founder loses control of property but retains ownership of the property as a beneficiary, this is called a bewind trust. In both forms of trust, it is clear that the founder loses unfettered control over the property and thus loses the ability to control, at will, the benefits that flow from the property. A trust is therefore a mechanism that allows the trustee in his fiduciary capacity to control the assets that are entrusted to him by the founder for the benefit of the beneficiaries of the trust.   

The legislative and case law basis for the separation of control

The legislative basis for the trust being an agreement that separates the founder from the control of the assets and by implication the control of the benefits associated with the assets is entrenched in section 12 of the Trust Property Control Act 57 of 1988 (“the Act”) which is titled “Separate position of trust property”. This section says that “Trust property shall not form part of the personal estate of the trustee except in so far as he as trust beneficiary is entitled to the trust property.”  

Section 12 of the Act confirms the view that, even where the founder is a trustee of the trust, he may not treat the assets as if they form part of his personal estate where he is entitled to exercise all the powers of ownership, such as unfettered control over the trust property by using the trust as a vassal entity to do his personal bidding. 

If the founder is a trustee and uses the trust as a vassal entity the entity is not a trust instead it is a sham or a façade that the court may disregard as never coming into existence because an agreement to relinquish control was never concluded. The seminal case in this regard is Humansdorp Co-operative Limited v Wait and Others (Case no 2896/2012, Eastern Cape Division of the High Court, Grahamstown, delivered on 1 November 2016) where the court allowed a claim against property purporting to be that of trust in satisfaction of a debt owed by a judgement debtor who purportedly formed a trust but instead formed a vassal entity, therefore, the legal benefit of asset protection was forfeited for lack of formation of a valid trust. In this case, what made the trust a sham were certain provisions of the trust deed which stipulated that a decision could only be made if the founder in his capacity as trustee agreed with the decision being taken, therefore, in the absence of his approval, no decisions could be taken with respect to the trust property. 

Lessons

When forming a trust, it is important that the founder divests himself of the property, in other words, he must unencumber the property in accordance with section 12 of the Act, thus freeing the property from his unfettered control and ownership.

The founder may maintain some control and ownership of the property; however, the type of control and ownership must change character and must be limited. Control changes character to the extent that the founder may only exercise control over the property in his fiduciary capacity as a trustee with another trustee in accordance with section 12 of the Act. Control by the founder is therefore limited by virtue of the encumbrance placed upon the property by section 12 of the Act which diminishes the founder’s unfettered control over the trust property.           

Ownership, on the other hand, changes character to the extent that the founder may own the property as a beneficiary of the trust, or the trust may own the property itself. As regards limitation, the ownership of the property is no longer what it once was in the sense that unfettered control, which is an essential requirement of ownership, has been limited because the founder, even as a trustee may not treat the property as if it were his own, that is, in accordance with section 12 of the Act.

Comment

When drafting a trust document, it is imperative that it is done in a manner that ensures that the founder has divested himself of the property which has been selected to form part of a trust. Failure to do so will result in an arrangement that is not a trust, and the law will not bestow upon that arrangement the legal benefits of a trust.

Mabhelandile Ntuli Attorneys are registered tax practitioners who provide assistance on a range of tax matters. We approach tax and legal issues with certainty.