Sham and simulated transactions: their structural and functional distinctiveness

Abstract

The common law doctrine of sham transactions and civil law doctrine of simulation are both difficult to understand and justify. There is no clarity as to their precise content, what they do, and thus what their added value is, but also what their underpinning rationale is. Looking at developments in English, French, Italian, and Chilean law in the context of property transfers, this dissertation argues that these doctrines serve important functions, but that to understand this, it is important to acknowledge that a legal transaction can be found to be a sham or a simulation both in a narrow and a broad sense.

A transaction found to be a sham or a simulation in a narrow sense features two distinctive structural elements. First, the parties recite in the documentary form certain rights and obligations that are different from the rights and obligations they intend to govern their legal relationship. Second, the parties share a common understanding of the divergence they create between the documentary form and the rights and obligations governing their legal relationship. While sham and simulated transactions in this narrow sense can be fraudulent, for instance where they avoid certain mandatory rules or defraud third parties, they do not have to be. In other words, fraud is not an essential requirement. For the same reason, and contrary to conventional understandings, the most distinctive function of the doctrines of sham and simulation transactions in this narrow sense is not to prevent fraud.

This dissertation aims to show that while the narrow understanding of the two doctrines protects the interests of third parties, it also enables the interests and purposes of the parties to the transaction to be implemented more effectively. In other words, so long as there is no prejudice caused to third parties, these doctrines permit the parties to split the operation of their legal transaction into their external legal effects vis-à-vis third parties and their internal binding legal effects between the parties. This function, I argue, is both useful and justified for it allows the parties to devise efficient and equitable legal structures which give better and more precise effect to the aims of their transaction when the law fails to provide them. This can occur both by filling gaps in the law and by facilitating subtle legal changes outside the conventional framework of the legal system.

This dissertation also shows that, alongside the narrow sense of sham and simulation, courts sometimes find that a transaction can be a sham or a simulation in a broad sense. Two cases exemplifying this broad sense are analysed in detail. First, when courts determine that transactions avoiding and circumventing mandatory law are shams and simulations, and, secondly, when they determine that self-declared trusts are in fact shams. In this broad sense, sham and simulated transactions do not feature common distinctive features. Compared with the narrow sense of the terms, sham and simulated transactions in this broad sense lack precise content. Rather, they are transactions where form and substance diverge in a vague sense, and where the term 'substance' has an open texture.

Yet, finding that a transaction is a sham or a simulation in a broad sense still has its uses. By determining that a transaction is a sham or a simulation in a broad sense, courts disregard the documentary form of legal transactions to ensure that the policy of other legal rules is effectively upheld and to better protect the interests of third parties. That said, it also comes at the cost of consistency and internal coherence, and therefore, wherever possible, more specific doctrines, such as transactions in fraudem legis and purposive statutory interpretation, should be preferred over this broad interpretation of sham and simulation.