Legal Definitions - Sham transaction

A sham transaction is a deal, agreement, or transfer that appears legitimate on paper but lacks genuine substance or purpose in reality. It's an arrangement designed to create a false impression, often to deceive others, avoid legal obligations, or gain an unfair advantage. While it might have all the formal documentation, a sham transaction doesn't reflect a true change in ownership, responsibility, or financial risk, and therefore has no real-world effect or tangible consequences. Courts can declare these transactions invalid or "void" because they are not what they purport to be.

Here are some examples to illustrate this concept:

• Example 1: Fictitious Business Expenses for Tax Avoidance
  A business owner, hoping to reduce their taxable income, creates invoices for "consulting services" from a shell company they secretly control. No actual consulting work is ever performed, and no money truly changes hands in an arms-length transaction; the funds simply move between accounts the owner controls. The owner then claims these fake expenses on their tax return.
  How this illustrates a sham transaction: This is a sham because the "consulting service" transaction exists only on paper to create a false expense. There is no genuine exchange of services or independent business relationship, and its sole purpose is to deceptively lower the business's tax liability.
• Example 2: Transferring Assets to Avoid Creditors
  An individual facing significant debt and potential bankruptcy "sells" their valuable antique car to a close relative for a fraction of its market value. The relative never takes possession of the car, and the original owner continues to drive and maintain it as if nothing changed. The "sale" is documented, but there's no real transfer of control or ownership intent.
  How this illustrates a sham transaction: The "sale" of the car is a sham because, despite the paperwork, there was no genuine intent to transfer ownership or control. The transaction was created to hide the asset from creditors, making it appear as though the individual no longer owns the car when, in reality, they still do.
• Example 3: Inflating Company Revenue to Attract Investors
  A startup company, struggling to meet revenue targets, enters into a series of "sales agreements" with another company secretly owned by one of its own executives. These agreements record large sales of products, but no actual products are ever delivered, and no real payment is exchanged. The purpose is to make the startup's financial statements look much stronger to potential investors.
  How this illustrates a sham transaction: These "sales agreements" are shams because they create the illusion of revenue and business activity where none exists. There is no genuine commercial exchange of goods or services, and the transactions are designed solely to deceive investors about the company's financial health.