The recently leaked Panama Papers appear to expose widespread use of offshore trusts for tax evasion, money laundering, and other illegitimate forms of asset protection. These developments animate our co-authored essay Sham and Remedial Doctrines, forthcoming in Trusts & Trustees, published by Oxford University Press. In it, we seek to articulate a general theory of sham, to identify the main choices legal architects have in designing legal rules to combat sham, and to explain the legal regime governing fraudulent transfers in the United States.
We understand sham as having two conceptual elements: falsehood and intent to deceive. The first element, falsehood, exhibits a fairly wide range of typological variation. Something might be logically false (2+2=5) or empirically false (we were born on Jupiter). It is the second element of intentional deception that forms the core of the concept of sham. The intentional production of falsehood, such as a brazen lie or a more subtle omission of material information, always reflects badly on the speaker, absent some valid excuse. And it is the intention to deceive that produces the falsehood in the context of inheritance and tax law. A sham in this area often requires elaborate planning, usually with the help of skilled legal professionals. In other words, there are no unintentional shell companies or offshore trusts. Thus, the unique characteristic of a sham is the illegitimate use of what would otherwise appear to be a proper form of conveyance to defeat a substantive legal prohibition. This characteristic of facial legitimacy poses special problems of detection and enforcement because the sham’s underlying fraud is concealed by a false appearance of propriety.
There are two structural options for designing civil remedial doctrines to address frauds perpetrated in the form of a sham. First, should a sham avoidance doctrine require evidence of the challenged wrongdoer’s subjective fraudulent intent, or should the doctrine alternatively allow for more objective proof, such as circumstantial evidence of surrounding facts indicative of a sham transfer? Until neuroscience develops more advanced methods of detecting fraudulent mental states, an objective standard is bound to be more efficacious. Second, is a bright-line rule prohibiting sham transactions or a holistic standard for ex post evaluation of a sham more likely to be effective? Bright-line rules too often fail to capture the multiplicity of shams that wrongdoers might create, unless they can reliably define a universe of legal moves that are likely to be fraudulent. By contrast, standards allow adjudicators to conduct probing fact-intensive ex post analyses of a challenged sham transaction, but the fact-intensive nature of this type of review increases administrative costs and relies on decision-makers who are both aware of legal trends and suspicious of potentially fraudulent activity.
Today, in the United States, the Fraudulent Transfer Doctrine represents the dominant approach for identifying and remedying sham transactions. The doctrine’s first prong deems a transfer to be fraudulent if made with actual intent to defraud. But fraudsters rarely come out and brag about their shams to avoid creating an incriminating trail of evidence of their fraudulent plans. To mitigate this evidentiary problem, the doctrine supplies an objective legal standard for ascertaining fraudulent intent without direct evidence of the wrongdoer’s state of mind: circumstantial evidence establishing one or more of eleven enumerated, non-exhaustive “badges of fraud,” such as the concealment of, post-transfer control of, or act of absconding with fraudulently transferred property. The doctrine’s second prong also provides objective criteria to address the related problem of constructive fraud: without regard to proof of fraudulent intent, certain transfers of property without adequate consideration are deemed inherently suspicious, and therefore fraudulent, if the transferor’s assets are consequently insufficient to satisfy creditor claims. This alternative criterion further protects creditors who would otherwise be unable to obtain direct proof of fraudulent intent. This doctrine is implemented after the fact by an adjudicator who may holistically assess the evidence of the validity of the transaction. Our essay then surveys other specialized sham avoidance doctrines, developed to address abusive tax trusts and spousal disinheritance, which illustrate experimentation with both subjective state-of-mind criteria and rule-based prohibitions, with mixed reception and success.
Alexander A. Boni-Saenz is an Assistant Professor Law at Chicago-Kent College of Law, Illinois Institute of Technology.