When trusts go wrong - Advisory - Insights

Actions speak louder than words. If these recent South African court cases don't convince you to administer your family trust according to the letter of the law, nothing will. BDO's Ricardo Teixeira CFP® and Phia van der Spuy of Trusteeze choose three of their most instructive cases.

The Slip Knot Case: The perils of puppet trustees

There is no better demonstration of the danger of being a sleeping trustee than the Slip Knot Investments 777 (Pty) Ltd case. In this case a Free State farmer agreed to be a trustee in a trust that was set up and managed by his brother and his brother's son. The farmer played no part in the administration of the trust and simply signed documents when he was requested to.

One day in November 2007, the farmer's nephew urgently requested his uncle to sign some documents in the presence of a commissioner of oaths. The farmer was extremely busy on the day in question, but after four phone calls from his nephew he eventually agreed to go into the bank to sign "a bundle of documents comprising some 75 pages that had already been signed by his brother and nephew." Neither the farmer "nor the bank manager or any of the two witnesses read the documents or paid any attention to their contents" - they simply signed and/or initialed as required and faxed them off to the farmer's brother.

Unbeknownst to the farmer, he had signed surety on a R6 million loan the trust obtained to fund his brother and nephew's business activities elsewhere in Africa. The first the farmer heard of the suretyship was when his brother's African investments turned sour and he was asked to cough up the R6 million when the trust could not repay the loan. Predictably, the dispute ended up in court and although the Free State High Court found in the farmer's favour (describing his mistake as "reasonable") the Supreme Court of Appeal overturned this decision and ordered the farmer to pay R7.95 million to Slip Knot Investments.

The Supreme Court of Appeal believed the farmer's testimony that he did not know what he was signing, and it even acknowledged that his "mistake may have been induced by fraud, i.e. the omission of his brother or his nephew to draw the suretyship to his attention." But this did not change the fact that the farmer should have been more careful, the Supreme Court of Appeals found.

this passage from their (unanimous) judgement is worth quoting from at length:

The court below [i.e. the High Court] emphasised the fact that the respondent was a farmer and not a businessman and that he had nothing to do with the trust and the loan advanced to the trust. This is incorrect. The respondent was a trustee of the trust. He may have been a farmer but this is of no consequence. The respondent had his own trusts and managed them. He must have known what a trust was and what the duties and responsibilities of a trustee were. Slip Knot was entitled to rely on the respondent's signature as a surety just as it was entitled to rely on his signature as a trustee.

Griessel v de Kock: Piercing the corporate veil

If you're looking for a quintessentially South African family feud, look no further than the recent Griessel versus de Kock case. The case centered around the decision made by the trustees of a family Trust to prevent Harold, (whose siblings were also beneficiaries and whose mother was one of the trustees) from visiting land the trust owned in the Greater Manyeleti Game Reserve, after Harold had a falling out with the rest of the family over the commercial development of the property.

The trustees thought they could hide behind legal structures to elbow Harold out. First, the game reserve was fully owned by a company held by the trust. And second the trust was what's called a discretionary trust: trustees could "in their entire and absolute discretion" choose whether or not to confer beneficiary rights on an individual.

In the High Court, the family claimed that the right to use the farm was not a benefit to beneficiaries of the trust because the farm belonged to the company and not to the trust. The judge ruled that this argument had no basis since the company was wholly owned by the trust and certain family members were also acting as directors of the company. The judge memorably stated: "If the trust then is this empty shell with no decision-making powers over its property then the question is why it still exists."

The trustees also argued that, because of the discretionary nature of the trust, they had the right to suspend Harold's rights as beneficiary at any point. This too was struck down, because Harold had enjoyed the right to visit the farm in the past. The Supreme Court of Appeal held that trustees have an obligation to treat beneficiaries even-handedly and that a beneficiary is protected against trustees' arbitrary and discriminatory treatment. "Differential treatment of beneficiaries without a justifiable basis is not allowed," explains Phia. "The only time preferential treatment is allowed is if one beneficiary is demonstrably more needy than the rest."

Harold's right to visit and enjoy the farm was reinstated and he was awarded costs.

IK v MK: The soon-to-be-ex-spouse

No article about the perils of reckless trust management would be complete without at least one divorce case. IK and MK were married out of community of property with accrual in 1993. From Day 1 the husband handled the couple's finances. When the marriage was healthy, says Phia, "the husband traded through companies and close corporations which he held in his personal name. But as soon as the marriage showed cracks and the wife had an affair," he immediately arranged their affairs in trust structures, moved his membership in a CC to the trust at no cost and reduced his loan accounts to the trusts (which were assets in his estate) dramatically over a short period.

The judge in this 2020 case, stated that it had become the norm that trusts are consistently abused to conceal assets that the founders and trustees are not willing to disclose to interested parties. The husband controlled the assets in the trust, the wife, as trustee, was never consulted, and he took decisions alone. He mingled his personal assets with trust assets and paid his living expenses from the trusts. Accounting journals were passed without cash flowing. The lines were blurred between the husband's assets and those of the trust. The trust instrument allowed the husband to deal with the trust assets as he wished. He had absolute powers to decide who the beneficiaries should be and how the assets should be distributed.

The judge ruled that "he uses the trusts as his alter-ego and only seeks refuge behind their existence when it suits him and he stands to benefit out of them." The trust instruments, concludes Phia, "were also drafted in such a way to benefit the husband and to give him control over the trusts' assets, and he could basically decide how, when, and if his wife would benefit from the trusts."

The judge ordered the ‘veneer' of the trusts to be pierced to determine the accrual of the husband's estate. The assets the husband tried to keep for himself in the trusts were valued in excess of R 35 million. The wife was therefore entitled to almost half of this sum (after taking into account the commencement values at the start of the marriage).

The moral of the story

As these three examples have shown, poor trust administration has the potential to poison relationships and/or to cost you millions of rands.

It's totally normal to hope that all of your family relationships will end up being long, happy and loving. But when it comes to setting up and managing family trusts we advise catering for every eventuality and employing a professional to ensure that all your t's are crossed and your i's are dotted.