Establishing an Offshore Trust

Christopher McKenzie
Partner

The Mill Mall, P.O. Box 92, Wickhams Cay 1
Road Town, Tortola
British Virgin Islands
Tel: (284) 494-2204 Fax: (284) 494-5535
Email: christopher.mckenzie@walkersglobal.com

ESTABLISHING AN OFFSHORE TRUST – REQUIREMENTS FOR A VALID SETTLEMENT


This is a topic of vital importance. Non-specialists are not always aware of the niceties of the rules for creating a valid trust with the consequence there are thought to be a good many trusts around which could be challenged (for example by tax authorities, creditors or disgruntled relatives of the settlor) on the grounds that some requirement has not been complied with. The basic rules are set out below.

These basic rules essentially reflect requirements of English trust law most of which apply in those of the British Overseas Territories and the former British colonies in which the modern principles of English common law and equity are generally applicable. However there may be local variations and some examples of these are set out below.

It is to be stressed that this paper is only intended to provide a basic overview of the requirements for establishing a valid settlement: for a detailed consideration of the relevant principles of English law, practitioners should refer to the commentaries in the leading trust textbooks .

It is also important to note that the requirements which are set out below relate to inter vivos trusts: the requirements for a valid testamentary trust are more complex and are outside the scope of this paper. These requirements are also confined to ‘express trusts’ – i.e. those which are intentionally set up and do not relate to trusts (such as resulting or constructive trusts) which arise by operation of law. Nor do they cover ‘bare trusts’ (or nomineeships); bare trusts arise where the trustees hold property on trust for a single, absolutely entitled beneficiary (who could be the settlor or a another person) and the trustee’s only duty is to transfer title to the property to the beneficiary or her nominee if so directed.

1. LANGUAGE SUFFICIENT TO CREATE A TRUST

No technical language is needed to create a trust, but the language needs to be sufficiently clear to show an intention to create a trust, to identify the property which is to be the subject of the trust, and to identify with sufficient certainty the beneficiaries (or sometimes purposes) and how the property is to be applied. These requirements are known as the ‘three certainties’ and a professionally drafted trust instrument which has been drawn up by a lawyer from the governing law jurisdiction should ensure that these requirements are satisfied. Difficulties can, however, arise when a standard draft is adapted by someone with insufficient knowledge or when a foreign precedent is used.

As a general rule the terms of the trust will be set out in writing in a ‘trust instrument’ which, if under seal (or if it satisfies the requirements for a deed under the laws of the relevant jurisdiction) , may be referred to as a ‘trust deed’. Sometimes both the trustees and the settlor will be parties to the document and it may be referred to as a ‘settlement’. (‘Settlement’ is a wide term, sometimes referring to the document which creates the trust, sometimes to the act of creating the settlement, and sometimes to the trust itself).

Where the settlor prefers that his name does not appear on the face of the document, the trust instrument is executed only by the trustees. But note that if the settlor does not sign there needs to be evidence outside the document that the settlor has declared a trust on the particular terms. Where only the trustees execute the document, the instrument is usually described as a ‘declaration of trust’ (but this too is a wide expression which may be applied to other types of trust instrument).

2. TWO MAIN METHODS OF CONSTITUTING A TRUST

The execution of the trust instrument does not itself create a trust (except where the settlor is also sole trustee). This is a trap for non-trust lawyers, especially since at the planning stage loose language may be used, such as ‘we need to incorporate a company with an overriding trust’.

A trust is effective only when it has been ‘completely constituted’. This is normally achieved either:

(a) by the settlor declaring himself a trustee of his own property (not commonly encountered in offshore practice), or

(b) by the settlor transferring the property to the trustees (or causing it to be transferred) and declaring the trusts on which the property is to be held.

3. METHOD (A): SETTLOR DECLARES HIMSELF A TRUSTEE OF HIS OWN PROPERTY

3.1 IDENTIFYING THE TRUST PROPERTY

Where the trust is constituted by method (a) (where the settlor declares himself to be the trustee of his own property), he or she must identify, with sufficient certainty, the property to be comprised in the trust. Clearly no problem arises where the declaration relates to specific property (e.g. ‘all my shares in XYZ Limited’ or ‘my El Greco painting of the Madonna and Child’), but complications can arise where the declaration relates to part of the settlor’s unascertained property in which he retains an interest (e.g. where he declares a trust over 30 of his 100 of his shares in XYZ Limited or over $10 from $100 held in his account at HSBC). Such difficulties would not arise if the settlor were first to declare himself trustee for himself and another as beneficial co-owners with specified factions or percentages. Until recently it was thought that unless such a declaration were made, the trust would fail for uncertainty of subject matter where an undefined part of a larger holding of relatively identical assets is settled. Although the courts have adopted a more pragmatic approach in a number of cases, these cases have been criticised and the most prudent course of action is still to segregate the assets settled from those which are to remain the settlor’s.

3.2 WHERE THE SETTLOR IS NOT THE SOLE TRUSTEE OF THE TRUST

Normally where a trust is constituted by method (a), the intention will be that the settlor will be the sole trustee of the trust, so that, once he has made the necessary declaration, he will henceforth hold property, which he previously held absolutely, on specified trusts. However in Choithram International S.A. v Pagarani the Privy Council ruled that a trust was properly constituted where one of a larger body of trustees had property vested in him and declared himself a trustee of that property for the existing trust: the Board held that his declaration was effective and that he was bound to transfer the property into the names of all the trustees.

4. METHOD (B): TRANSFER OF PROPERTY TO TRUSTEES COUPLED WITH A DECLARATION OF TRUST

4.1 DECLARING THE TRUST

The second leg of (b) (declaring the trust) will usually be covered by the trust instrument which is referred to in paragraph 1 above if it is signed by the settlor. If it is not signed by the settlor there must (as already mentioned) be other evidence that the settlor is declaring a trust in the terms of the trust instrument. Best practice obviously dictates that, if at all possible, the settlor’s declaration should be reduced to writing and retained by the trustees. This requirement (the settlor’s declaration) was historically, frequently overlooked in offshore practice, but it is important that practitioners should ensure that the declaration is made, i.e. so as not to give anyone wishing to do so ammunition to challenge the trust’s validity on the basis that it was never properly constituted.

‘Nominee settlors’ should never be used either as parties to settlements or for any other purposes, since a nominee settlor is a concept which is not legally recognised. The settlor is the beneficial owner of the asset settled. If he does not make the declaration, the trust will not be properly constituted. If the legal owner is not the beneficial owner of the assets, it is the beneficial owner who must make the declaration.

4.2 TRANSFER OF ASSETS

The first leg of (b) (transfer of property) requires there to be an effective transfer of title (in whatever form is appropriate to the particular property) to the trustees. In some cases the court will treat a trust as completely constituted even before the trustees’ title has been perfected, e.g. on the basis that the settlor has done everything in his power to effect the transfer or on the basis that the trustees or the beneficiaries have given consideration. However, it is dangerous to rely on this, although this topic is beyond the scope of this paper.

Unless the settlor is the sole trustee of the trust, every effort should therefore be taken to ensure that the trust property is effectively transferred to the trustees and (especially if the trust property is situated in another jurisdiction) advice from lawyers from other relevant jurisdictions should often be taken to ensure that the transfer is effective (see paragraph 17 below).

No attempt is being made in this paper to summarise the requirements which will need to be satisfied in order to transfer the trust assets to the trustees, especially since these requirements will vary from jurisdiction to jurisdiction. However, these factors will often be relevant:

(a) Domestic land is transferable by satisfying the requirements of the situs jurisdiction. Writing is generally required and if the jurisdiction has a system of land registration the transfer of legal interests in the land is likely to require an entry in the jurisdiction’s land register. If the land is unregistered, a deed may be needed. There may also be land licensing requirements which must be satisfied and stamp duty and other government fees may be payable.

(b) Be particularly careful with foreign immovable property. The direct holding of foreign land by the trustees of a trust is exceptional, since it imports the foreign law into the law governing the trust and the trust might not be regarded as valid under the law of the situs (for instance if it breaches the perpetuity rules of the situs jurisdiction). The usual practice is for the land to be held through an underlying company. Direct land holding should only be contemplated in special situations (for example where there is a tax advantage) and then only with local professional advice.

(c) If registered shares in a BVI company are to be settled there needs to be a transfer to the trustees with registration in the trustees’ names. (In the case of nominee shareholdings where only the equitable interest is being transferred to the trust a different procedure needs to be adopted: this would usually involve an assignment and declaration of trust by the existing beneficial owner.

(d) Under English law, bearer shares and chattels are transferable by delivery. This is another pitfall for the unwary, since it will not simply be sufficient for these items of property to be referred to in the trust instrument as the property settled: the trustees must physically take delivery of them, although in practice a nominee or agent is sometimes appointed for these purposes.

(e) A cheque is not cash: it amounts to no more than a mandate to the bank to transfer funds which the donor can revoke, and which is revoked by the donor’s death. A trust will not therefore be constituted on receipt of the cheque. The payment does not take effect until the cleared funds are in the hands of the trustees. This issue can be critical in the case of deathbed planning: if the settlor dies before the cheque clears no transfer will have been made and the monies will remain part of her estate. It may also be critical if it is essential that the trust be established on or before a certain date (for instance before the end of the tax year). An irrevocable bank draft on the other hand will constitute a trust immediately.

(f) If a debt or other chose in action is incapable of assignment, for example because the contract under which it arises prohibits assignment, then it is impossible for it to be settled by a transfer to the trustees; however, unless this is also prohibited, it may be settled by declaration of trust. Certain property (such as certain UK pension rights) may also be incapable of assignment as a consequence of local statutory provisions.

(g) Future vested or contingent interests under trusts may be settled without consideration, but ‘mere expectancies’ cannot be settled without consideration (although nominal consideration will suffice). The difference between future contingent interests and expectancies is however a subtle one, and the distinction is beyond the scope of this paper. Similar issues apply to interests in settled property which might be appointed to the settlor under a power of appointment: to be effective, consideration will be needed.

(h) Interests in unadministered estates can be settled: the property settled is the right to have the estate duly administered, but it is not yet clear whether (as a matter of trust law) specific assets which are comprised in the deceased’s residuary estate can be settled without consideration.


5. THE THIRD METHOD OF CONSTITUTING A TRUST: THE CREATION OF A NEW SETTLEMENT IN THE EXERCISE OF A POWER

In addition to the two methods of creating a trust which are referred to above (settlor declaring himself a trustee and transfer of trustees coupled by an appropriate declaration) there may be added a third: the exercise of an appropriate dispositive power under an existing trust. If the power is exercised properly the property within the scope of the power may, following its exercise, become subject to new trusts. Typically the power would be a power of appointment or a power of advancement.

Clearly one issue which should always be considered is whether the power in the existing settlement is wide enough to enable a new settlement to be created. A widely crafted power of appointment and associated powers which are found in most modern offshore discretionary settlements will often be wide enough to achieve this and the statutory power of advancement in section 32 of the English Trustee Act 1925 has been held wide enough to enable new trusts to be created for the beneficiary’s ‘benefit’. However the practitioner should always look at the wording of the relevant provisions of the existing settlement and the relevant authorities very carefully to ensure that the proposed exercise of the power does not amount to a fraud on a power or an excessive execution of a power.

6. ADDING PROPERTY TO THE TRUST FUND OF AN EXISTING TRUST

One needs to remember that when property is added to the trust fund of an existing trust (whether it is one which has been settled by a nominal sum of, for example, $10 or one the trust fund of which is comprised of substantial assets) what has actually happened, as a matter of trust law theory, is that a second trust has been created, albeit that these trusts will be administered as a single trust. It follows from this that the trust must also be properly constituted in relation to the added property, with the result that it will not simply be sufficient for the settlor merely to transfer the added property to the trustees: he must also satisfy the second leg of requirement (b) in paragraph 2 above by making the requisite declaration. This declaration will often take the form of a deed (or memorandum) of addition. Another consequence of this is that, for the purposes of the laws relating to voidable dispositions, it will be the date of the addition (and not the date of the original settlement) which will be relevant.

Remember also that the trust instrument may contain additional requirements relating to additions to the trust fund of an existing trust: for example many precedents require the trustees to ‘accept’ the added property ‘as part of the trust fund’. If the trustee is a company, this will mean entering into the appropriate resolution (and note also that, however flexible company law might be in terms of enabling decisions to be ratified subsequently, trustees’ decisions cannot be backdated). In many cases, therefore, it might be advisable for the trustee to be a party to a deed or instrument of addition (which would be executed after the appropriate trustee’s resolution has been entered into).

7. LEGALITY

A trust is invalid if its objectives are regarded as illegal under its governing law. Categories of illegal trusts are set out below.

7.1 TRUSTS WHICH OFFEND THE RULES RELATING TO PERPETUITIES AND ACCUMULATIONS

The perpetuity rules take us into a notoriously complicated area of law. They are essentially rules of public policy. Their purpose is to prevent interests under the trust from vesting at too remote a time in the future, and trusts from tying up property for too long a period.

In broad terms the effect of the rules is to apply a ‘perpetuity period’ to a trust. Interests under the trust must not vest after the end of that period and, in the case of limited interests, must not last beyond the end of the period.

The perpetuity rules vary from jurisdiction to jurisdiction.

The BVI has modified its perpetuity rules so that they are similar to those in England with one major exception. In England it is possible, subject to appropriate wording in the trust instrument, to have a perpetuity period of 80 years. In the BVI this has been extended to 100 years. These fixed periods are optional alternatives to the maximum English common law perpetuity period of ‘lives in being plus twenty-one years’ (for which the typical ‘royal lives clause’ is generally used).

Under the original perpetuity rules an interest under a trust was void from the outset if it was capable of vesting outside the perpetuity period even if not certain to do so. Under the BVI’s reformed rules, it is permissible to ‘wait and see’.

With limited exceptions the reformed rules apply only to BVI trusts created after 1 November 1993.

Under English law there are statutory restrictions on the period for which the income of a trust can be ‘accumulated’ (i.e. added to and treated as capital), but these restrictions have never been applied in the BVI where the Trustee Act now provides that a trust’s income can be accumulated for the full trust period.

It is for the trust specialist to ensure that the trust instrument complies with the relevant perpetuity and accumulation requirements.

7.2 CERTAIN TRUSTS WHICH TRY TO ALTER THE DEVOLUTION OF PROPERTY ON BANKRUPTCY

A trust in favour of an individual cannot be made conditional on the property not being used to satisfy the individual’s creditors: the condition (rather than the trust) will be void, with the result that, in the event of the beneficiary’s insolvency, his beneficial interest will vest in his trustee in bankruptcy.

Furthermore an individual may not create a trust of his own assets for an interest which terminates on his own bankruptcy. There is however nothing to prevent him from creating a trust conferring an interest on another beneficiary and terminating on that beneficiary’s insolvency. Such trusts are in fact common and are known as ‘protective trusts’.

7.3 TRUSTS WHICH TRY TO ALTER THE DEVOLUTION OF PROPERTY ON DEATH

An absolute owner of property can only dispose of property on death by will or codicil. There is more to be said on this topic (although outside the scope of this paper) because properly drafted and administered trusts often serve as effective probate avoidance vehicles.

7.4 MISCELLANEOUS OTHERS

Examples include trusts which promote immorality or dishonesty, or are contrary to public policy.

8. THE BENEFICIARY PRINCIPLE

With the exception of certain trusts for purposes, a trust must be for the benefit, directly or indirectly, of one or more persons (individual or corporate) so that some person has locus standi to enforce the trust.

Although detailed consideration of trusts for purposes is beyond the scope of this paper, trusts for purposes will invariably fall within these heads:

(a) Charitable trusts - trusts for charitable purposes have always been regarded as valid (if they fulfill certain conditions) because they can be enforced on behalf of the public by the Attorney General. The purpose will however need to be exclusively charitable under the law of the governing law jurisdiction.

(b) The anomalous cases - the courts have permitted from time to time specific types of purpose trusts. These are regarded as anomalous because they cannot be justified on principle. They include, for example, trusts for the maintenance of tombs.

(c) Statutory purpose trusts - certain jurisdictions, including Bermuda, the BVI, Anguilla and The Bahamas, have introduced legislation which permits the creation of trusts for non-charitable purposes subject to certain conditions. In the Cayman Islands, such trusts are permitted under the Caymanian ‘STAR trusts’ legislation. The enforcement problem is addressed by providing for the trust to appoint an ‘enforcer’.

9. ADMINISTRATIVELY WORKABLE

The theory is that a trust must be of a nature which is capable of being controlled by the court. The exact requirements for administrative workability are still being developed by case law.

10. WRITING SOMETIMES REQUIRED

Writing has never been a universal requirement for a trust. However in some jurisdictions there may be statutory requirements for writing. In England and Wales a trust of land is required to be evidenced in writing , although this would not permit a person to deny a trust if this would amount to equitable fraud, and similar statutory provisions apply in some of the offshore financial centres. In certain jurisdictions, such as England and Wales, dispositions of an equitable interest must also be in writing.

11. REGISTRATION OR FILING

The requirements vary from jurisdiction to jurisdiction. In the BVI any deed creating a trust is exempt from registration under the Registration and Records Act.

12. STAMP DUTY AND GOVERNMENT LEVIES

Again the requirements vary from jurisdiction to jurisdiction. There is a $100 trust duty on trust instruments creating trusts governed by BVI law (other than bare trusts and trusts for exclusively charitable purposes) and on instruments changing the governing law of a trust to BVI law. There are penalties for late payment and non-stamped trusts are inadmissible in civil proceedings , but non-payment of the duty will not invalidate the trust. In the case of a late stamped document the court has a discretion to admit it in evidence. Bahamian trust instruments, other than those creating bare trusts, are similarly liable to a $50 trust duty and similar consequences follow from the failure to comply with the relevant statutory provisions.

As regards BVI stamp duty, most international trusts will be exempt under section 90(3) of the Trustee Act.

13. GOVERNMENTAL CONSENTS

The trustee might need a licence under the laws of the relevant jurisdiction. In the BVI, the requirements for trust licensing are set out in the Banks and Trust Companies Act, 1990. In addition there are licensing requirements in respect of trusts of land in the BVI.

14. VOIDABLE AND IMPEACHABLE TRUSTS

An otherwise valid trust may in some circumstances be overturned in whole or part.

14.1 TRUSTS WHICH CAN BE ATTACKED BY THE SETTLOR’S CREDITORS

The statutory provisions of the various jurisdictions vary.

BVI law provides that in certain situations transfers such as those to trustees may be set aside if an individual settlor is declared bankrupt within specified periods of the transfer of property into trust. Similar provisions apply if a company makes a transfer within specified periods of the onset of insolvency and the company is placed in administration or liquidation. Perhaps more importantly, a trust made with intent to defraud creditors may be voidable, without limitation in time, under the BVI’s Conveyancing and Law of Property Act, section 81. On the basis of English authority it appears that creditors in this context include creditors not in existence at the time of the settlement. Thus a trust may be vulnerable if created by a settlor shortly before entering into a risky transaction, and even if the actual debts arise from some other transaction.

Other jurisdictions have passed ‘asset protection’ legislation which restricts the rights of creditors to attack a trust. An example of this is Anguilla’s Fraudulent Dispositions Ordinance 1994, the wording of which is fairly similar to that of the legislation which has been enacted by some of the other Overseas Territories and The Bahamas. This basically dilutes creditors’ rights by providing that they must bring claims within three years of the relevant disposition, by prohibiting most creditors to whom no obligation was owed at the date of the transfer (‘future creditors’) from making claims and by placing on the creditor the burden of proving the intent to defraud.

14.2 OTHER SITUATIONS

There are a number of other situations in which a court may set aside a trust; for example if it can be shown that the trust was created under duress or in ignorance or mistake or was procured by fraud, misrepresentation, or undue influence, or under specific statutory provisions.

Under BVI law, if land in the Territory is held in trust for a non-belonger without a licence, the land will be forfeited to the Crown.

15. SHAMS

In a very well known case in Jersey, the Rahman case, a trust was overturned as a sham. Slightly more recently in the UK a trust was held void for a similar reason. Although this is a developing area of the law, the crucial test is whether there was an intention to create a genuine trust in the first place. If there was an understanding between the settlor and the trustees that, despite the terms of the trust, the trustees would in practice administer it on the instructions of the settlor, i.e. treating it as his personal money box, then there is no trust. Although everything depends on the intention when the trust was created, the way the trust is administered may be treated as ex post facto evidence of what the intention was in the first place. Thus if the trustees’ file shows that on getting a fax from the settlor requesting a payment to be made to X, the trustees immediately make that payment without sufficient consideration as to whether or not this is a proper exercise of their trust powers, this might later be adduced in evidence by someone arguing in favour of a sham. The sham risk is increased if the trustees refer to the settlor as their ‘customer’ or ‘client’.

The way of avoiding the sham problem is (a) to ensure that proper advice is given to the settlor as to the effect of the trust, and in particular that he is relinquishing control and that the trustees are bound to administer the trust strictly in accordance with its terms and (b) to be meticulous in the administration of the trust.

When the question arises of whether a trust is a sham, the trustees must take a neutral rôle, seeking directions from the court if necessary. Their duty is not to argue the case for the validity of the trust according to its apparent terms but to hold and deal with the trust assets in whatever manner is appropriate, depending on whether a sham is or is not established.

16. CORE REQUIREMENTS

There has been much discussion about the core requirements of a trust and whether certain types of provision in a trust may be repugnant to those requirements. The risk is that such a provision will be struck out by the court or, in some cases indicate that (despite its dispositive provisions) the trust is no more than a bare trust or nomineeship for the settlor.

Some trust instruments purport to exclude, in its entirety, the duty of trustees to provide beneficiaries with trust accounts. This is considered to be incompatible with a trustee’s duty of accountability, and therefore repugnant to a trust. Certain jurisdictions like The Bahamas and the Turks and Caicos Islands have, however, enacted specific statutory provisions which cover this area.

For the same reason provisions stating that only the settlor (or the protector) can hold the trustees to task are likely to give rise to validity concerns.

Clauses exonerating the trustees from liability may also be struck down if they go too far; however the English Court of Appeal made it clear in Armitage v Nurse that an exoneration clause will stick if it excludes everything except fraud (although some jurisdictions have introduced laws limiting the extent to which trustees can be exonerated).

Watch out for provisions stating that beneficiaries’ interests are unassignable. These are sometimes included in trust instruments which have been drafted by US lawyers, since certain US states enable ‘spendthrift’ provisions to be included in trusts. Under English law, however, these provisions will not be recognised as a matter of trust law unless there is a ‘shifting clause’ which specifies what is to happen to the interest should the beneficiary attempt to assign it. (To the extent, if any, that the trust instrument records a contract which is binding on the beneficiary, the provision might however be valid as a matter of contract law, with the breach giving rise to a claim for damages only.)

If the settlor retains too many powers (for example if he reserves to himself the power to direct payments of capital, rather than merely a power of appointment over capital), he may not be regarded as having divested himself of his full beneficial interest in the trust property, with the result that the trust’s dispositive terms will be disregarded.

17. CONFLICT OF LAWS

In the offshore context, one has to be especially mindful of issues involving conflict of laws because the settlor, the trustees, the beneficiaries or the trust assets are likely to have connections with other jurisdictions and consideration of their laws may become critical (inter alia) to certain aspects of the trust’s creation. This is a notoriously difficult area in which there is still a great deal of uncertainty in relation to the ambit of some of the principles of English law. For this reason most offshore jurisdictions will have statutory provisions which attempt to resolve these areas of uncertainty by specifying what law determines a particular issue.

In the trust context, the following conflict of laws issues are likely to arise:

(a) Is the concept of a trust recognised in the settlor’s home jurisdiction/the jurisdiction in which the trust property is situated? Does the Hague Trusts Convention apply?

(b) What is the governing law (or proper law) of the trust?

(c) What law governs the settlor’s capacity to create the trust?

(d) What law governs the settlor’s capacity to transfer property to trustees?

(e) What law governs the trustees’ capacity to hold on trust?

(f) What law governs the essential validity of the disposition?

(g) What law governs the formal validity of the disposition?

(h) The enforcement of foreign judgments and variation orders, and the payment of foreign taxes

(i) Changing the trust’s proper law and ‘flee clauses’

(j) The forum for the trust’s administration

(k) The application of ‘forced heirship’ rules and foreign matrimonial property rights

Given the complexity of the relevant issues and the extent to which the laws of the various offshore jurisdictions differ, detailed consideration of conflict of laws is well beyond the scope of this paper. However, it is essential that conflict of laws issues be given proper consideration according to the circumstances of the case. Failure to do so may lead to invalidity of the trust or have other serious adverse consequences.

18. SPECIAL TRUST REGIMES AND NON-CHARITABLE PURPOSE TRUSTS

Finally instruments creating Cayman STAR trusts and BVI VISTA trusts will, in addition to satisfying the other requirements of the relevant legislation, need to include a direction or declaration to the effect that the provisions of the relevant legislation apply. As indicated in paragraph 8(c) above there are also certain conditions which will need to be satisfied when non-charitable purpose trusts are set up under offshore statutory provisions.


Christopher McKenzie
Partner
Walkers
March 2006


This paper is general in scope and is not intended to be comprehensive. It is not a substitute for legal advice.

THE SETTLOR WHO WANTS TO HAVE HIS CAKE AND EAT IT:
A GLOBAL SURVEY OF SETTLOR RESERVED POWER TRUSTS

Christopher McKenzie
Partner

The Mill Mall, P.O. Box 92, Wickhams Cay 1
Road Town, Tortola
British Virgin Islands
Tel: (284) 494-2204 Fax: (284) 494-5535
Email: christopher.mckenzie@walkersglobal.com

PART I

Introduction

The intention of this article is to provide only a basic overview of the laws of specified jurisdictions in relation to the ability of settlors to reserve specific powers to themselves in trust instruments. For a fuller treatment of these laws reference should be made to the more detailed texts . Furthermore the objective of this article is not to consider issues relating to the powers which protectors of trusts may have, although there is a substantial amount of overlap between the issues which this article covers and those relating to protectors (especially where the settlor is initially the protector of the trust).

Demand for settlor control

For many settlors, particularly those from non-trust jurisdictions or from family backgrounds in which well-administered trusts do not feature , the establishment of an inter vivos trust involves an appreciable leap of faith, particularly since, once the trust has been validly established, the settlor of an English trust has no right to interfere in its administration except to the extent that the relevant rights are expressly reserved by him by the trust instrument. This will especially be the case if the trust is a discretionary trust, particularly one which has been established offshore, since offshore trusts tend to be of a very flexible nature and to confer very wide powers on trustees.

Extent of trustees' powers

Typically trustees’ dispositive powers would include the power to add and exclude beneficiaries, the power to determine when, and to what extent, capital and income appointments are made in favour of beneficiaries or objects of powers, and the power to determine in favour of which of these beneficiaries these appointments are made. They would also include the power to transfer trust assets to the trustees of other trusts, the power to terminate the “trust period”, so that the default provisions of the trust take effect, the power to change the proper law of the trust, and the forum for its administration, and the power to retire and appoint other trustees to take over the trusteeship.

The administrative powers of trustees of both onshore and offshore trusts are usually similarly extensive: they would in most cases have the power to sell the assets which the settlor has transferred to them on establishing the trust and to reinvest the proceeds in other assets of their selection (which fall within a very wide range of investments in which they are authorised, by the trust deed or by statute, to invest). The trust instrument or statute is also likely to confer on the trustees other extensive administrative and managerial powers, such as the power to borrow and to lend: schedules of administrative and managerial powers in trust instruments will typically extend to many pages.

Trustees' powers are nevertheless circumscribed

Of course, whilst the dispositive and administrative powers which trustees have do tend to be extremely extensive, they are not completely unfettered: the powers must be exercised properly: that is to say that the trustees must exercise these powers in accordance with their fiduciary duties. Thus a trustee must exercise powers, whether dispositive or administrative, "for the purposes for which [they] were conferred on [the trustee] by the settlor and not perverse to any sensible expectations of the settlor, thereby keeping an even hand among all the beneficiaries except in so far as [the trustee] may properly discriminate between them”. Furthermore the trustee must exercise dispositive powers “responsibly in properly informed fashion, taking account of relevant matters and ignoring irrelevant matters” , must exercise administrative powers “in accordance with the duty of care, so far as not ousted by the trust instrument” , and must not exercise powers for its own benefit unless permitted to do so by the trust instrument or statute. Trustees are accountable to the beneficiaries for their stewardship of the trust property and if their powers are not exercised in a way which complies with their duties they will expose themselves to liability for the consequences of not doing so. Further protection is provided by the doctrine of fraud on a power . This requires trustees to exercise powers (whether dispositive or administrative) only in furtherance of the purpose for which they were confirmed on them. Any purported exercise of a power in breach of this doctrine will be void.

Settlors are still anxious to retain control

The fact that the law requires trustees to exercise their powers properly will, however, be of little comfort to settlors who are used to being in the driving seat and who are accustomed to exerting dominion over their assets. Whilst they might very well appreciate (when these are explained to them) the unique advantages of trusts as succession planning vehicles and as flexible ways in which to hold assets, the strong preference – and often the requirement – of many settlors, particularly those who are entrepreneurs , will be to continue to be able to determine which of their family members are to be the objects of their bounty – and when – and to what extent. Such settlors also prefer it to be a term of their settlements that they effectively retain control over the way in which the trust’s assets are invested and over the manner in which the trustees’ other administrative powers are exercised. In other words they want to “have their cake and eat it”.

In fact, far from being placated by the rules of equity which require trustees to ensure that the trust’s assets are invested in such a way as ensures that the value of the trust fund is preserved, many settlors are concerned about the implications of these rules. As the Jersey consultation paper which preceded the recent Jersey reforms which will be considered in part 2 of this article indicates, “settlors may well have acquired wealth through their astuteness and understanding of particular investment areas, and wish to apply their wisdom to the management of the trust funds”. Moreover these rules can have the effect that trustees are required, as a consequence, to sell assets which settlors intend to remain in trust until transferred to beneficiaries (or objects of powers) in accordance with the trust’s dispositive provisions. These concerns are more acute when shares in controlled companies are held in trust since the rules of equity require trustees to monitor and, where necessary, exercise their shareholder-powers to intervene in the affairs of these companies. Thus these rules of equity could require the trustee to replace the directors of the company (who might include the settlor and/or family members) by directors of the trustees’ own selection, so that the company can be managed in such a way as ensures that the value of the trust’s shareholding is preserved.

Many settlors will, as a consequence, be unwilling to part with control of their assets unless a mechanism is established whereby they can continue to retain dominion. Indeed many settlors (particularly entrepreneurs and those from non-trust jurisdictions) will not be prepared to part with legal title to the assets unless the trust instrument is drawn up in such a way that it reserves significant powers to them.

Difficulties with reserved powers under English law

To the extent that the relevant principles of English law apply to the trust, the ability of a settlor to reserve powers to himself is however limited, although, in practical terms, a great deal of uncertainty arises in determining exactly where the line is drawn between what is permitted and what is not. In the words of the draftsmen of a recent consultation paper , “there is little guidance as to where the boundary exists between powers being validly reserved and a trust failing on the face of the trust deed itself. This uncertainty invariably places draftsman [sic], settlors and trustees in a difficult position”.

On the other hand, as will be seen from the summary which is set out below, in North America the trust concept has developed rather differently and where it seems that the settlor can, during his lifetime, have much more extensive dominion without incurring the bare trust risk which is referred to in the analysis of the position under English law which follows.

Market demand

In the light of this, and since there is clearly both (a) a need to introduce a measure of certainty for settlors who intend to set up trusts in jurisdictions in which the relevant principles of English law would otherwise apply and (b) an increasing desire for reform which meets the legitimate needs of would-be settlor, a number of international finance centres have introduced legislation, the objective of which is to provide this certainty and to meet settlors’ expectations and requirements. These laws will be summarised in part 2 of this article. Whist this is broader in scope and is not solely designed to address the issue of settlor control, the British Virgin Islands VISTA trust legislation also provides a mechanism by which the settlor can, if he wishes to do so, reserve control over investment and other administrative matters at the director (company) level and the relevant statutory provisions, and how they can be utilised with this objective in mind, will therefore also be considered in part 2.

England and Wales

The Hague Trusts Convention

Article 2 of the Hague Trusts Convention , most of the provisions of which have been incorporated into English law , makes it clear that “the reservation by the settlor of certain rights and powers… [is] not necessarily inconsistent with the existence of a trust”. Nevertheless the extent to which the settlor of an English trust can reserve extensive powers to himself under the terms of the trust is limited.

The bare trust risk

If the settlor of the English trust (or of a trust in which the relevant principles of English law apply) reserves such wide powers and rights that it cannot be said that he has parted with any beneficial interest, he will merely have created a bare trust .

In the case of a trust which contains dispositive or other provisions which are to continue to have effect following the settlor’s death, a bare trust will fail to achieve its intended purposes, i.e. since the assets of the trust will then belong beneficially to those who are entitled to the settlor’s estate on his death and will not pass to (or continue to be held in trust for) the beneficiaries specified in the trust instrument without probate or other formality. This is because any purported disposition of assets held on a bare trust is testamentary and for such a disposition to be valid it must comply with the provisions of the relevant law on testamentary dispositions and, in practice, it will rarely do this. Even if it does comply with these provisions there will remain the need for beneficiaries to establish title through probate or other procedures.

The essence of the problem, therefore, is identifying the point at which it can be said that the settlor has failed to part with the entire beneficial interest.

So far as English law is concerned, the test of an effective succession trust (i.e. one which is not construed as a bare trust) is whether, at the outset, it imposes equitable duties on the trustees in favour of a person or persons other than the settlor.

The right and wrong sides of the line

On this principle all the following trusts are effective succession trusts under English law:

(a) S declares himself trustee for himself for life then for B.
(b) S transfers property to trustees to hold for B for life then for C, but reserves to himself a power of revocation.
(c) As (b), but S reserves to himself a general power of appointment.
(d) As (b) or (c), but the life interest is to S rather than B.

On the other side of the line a trust would not, it is thought, stand up as an effective succession trust if, in the words of Underhill and Hayton , “S transfers property to trustees on trust in S’s lifetime to pay the income or capital to him or at his direction and, after his death, to hold the capital equally for his children or for such other persons in such shares as S may designate in signed writing”.

As Underhill and Hayton go on to say “the critical distinction between a trustee holding to the order of the settlor [i.e. the bare trust situation] and a trustee holding to the order of the settlor only if the settlor orders it is a fine one, which a trustee can easily overlook by treating itself as bound to do what the settlor directs, even though he has not exercised his power of appointment or revocation…”.

Despite these problems, it is considered that a “revocable” or “general power of appointment” trust can be an effective means of satisfying the needs of those clients who wish to provide for succession but to have control in reserve over the trust's dispositive provisions during their lifetime.

It seems that reservation to the settlor of the power of investment (or the power to direct the trustees in relation to how their investment powers must be exercised) might not in itself give rise to the risk that an English trust will be a bare trust, but if the trust instrument reserves other significant powers and interests to the settlor such a risk could well arise.

If the specified powers to give directions to the trustees are reserved to the settlor subject to fiduciary obligations, the trustee must not comply with those directions without considering their propriety and the settlor could face liability for any losses which arise from not complying with his fiduciary obligations.

Shams

If the trust deed omits provisions, or relevant provisions, reserving powers to the settlor and notwithstanding this, the relevant powers are exercised in accordance with his instructions, then the result might be that the trust will be regarded as a sham. If the trust is held to be a sham, this will have consequences similar to those which arise from conferring excessive powers on the settlor: the trust will be no more than a bare trust for the settlor.

In a very well known case in Jersey, the Rahman case, a trust was overturned as a sham. Slightly more recently in the UK a trust was held void for a similar reason. Although this is a developing area of the law, the crucial test is whether there was an intention to create a genuine trust in the first place. If there was an understanding between the settlor and the trustee that, despite the terms of the trust, the trustee would in practice administer it on the instructions of the settlor, i.e. treating it as his personal money box, then there is no trust. Although everything depends on the intention when the trust was created, the way the trust is administered may be treated as ex post facto evidence of what the intention was in the first place. Thus if the trustee's file shows that on getting an email message from the settlor requesting a payment to be made to X, the trustee immediately makes that payment without sufficient consideration as to whether or not this is a proper exercise of its trust powers, this might later be adduced in evidence by someone arguing in favour of a sham. The sham risk is increased if the trustee refers to the settlor as its “customer” or “client”.

Although, following the decision in the Rahman case, there was a considerable amount of concern to the effect that many trusts (and, in particular, offshore trusts, so many of which tended to be administered following the wishes of settlors) were no more than shams, unless it can be proved that both the settlor and the original trustee intended the terms of the trust instrument to deceive third parties , it is probably more likely that most of these trusts are not shams at all: rather it is more probable that these trusts are merely being badly administered and that other adverse consequences will follow. These consequences might include potential liability for the trustee and the possibility that discretions might be regarded as never having been validly exercised, (i.e. on the basis that the trustee never consciously applied its mind to their exercise ).

The United States Of America

The laws of the United States of America would appear to be more liberal than those of England and Wales in terms of permitting the settlor to retain extensive reserved powers.

Until the mid 1930s, the position in the United States of America, where the trust concept has developed somewhat differently from the way in which it has developed in England and Wales, was very similar to that which had been inherited from England.

In 1957 s. 57 of the Restatement of Trusts (Second) was however amended so that it read as follows:

“Where an interest in the trust property is created in a beneficiary other than the settlor, the disposition is not testamentary and invalid for failure to comply with the requirements of the Statute of Wills merely because the settlor reserves a beneficial life interest or because he reserves in addition a power to revoke the trust in whole or in part, and a power to modify the trust, and a power to control the trustee as to the administration of the trust.”

Although, since 1957, there were some anomalous decisions , the trend of modern authorities has been to uphold inter vivos trusts no matter how extensive the settlor’s reserved powers have been . Indeed, according to the commentary on the Restatement of Trusts (Third) ,

“However much some decisions may obscure the point, an alleged disposition is to be upheld if the admissible evidence satisfies the court that a property owner intended by the acts and oral or written communications involved to create a trust… If so, it does not matter what interests are then given or retained – or that an inter vivos arrangement serves, by transfer or contract, the same purposes as are served by wills… Asking whether something is a ‘trust’ or ‘mere agency’ is at best question begging… And assertions that a settlor must relinquish ‘dominion and control’ over the property are simply wrong. Such statements confuse the issue, and maybe the reader, ignoring the reality that these very courts regularly and properly find valid trusts where settlors have retained complete control…”.

Moreover s.303 of the Uniform Trust Code, 2000 provides that, for so long as a trust is revocable and the settlor has capacity to revoke the trust, the rights of the beneficiaries are subject to the control of, and the duties of the trustee are owed exclusively to, the settlor. Such a provision seems very alien to those who have been trained in jurisdictions in which English law applies and in which it is axiomatic that it is to the beneficiaries, and not to the settlor, to whom the trustee owes its duties.

PART 2

The British Virgin Islands

Section 86 of the Trustee Act

The first offshore jurisdiction to enact legislation providing for settlor reserved powers was the British Virgin Islands (“BVI”). Section 86 of the BVI’s Trustee Act (which was inserted into the original Act by the Trustee (Amendment) Act, 1993) provides as follows:

“(1) An instrument creating a trust may contain provisions by virtue of which the exercise by the trustees of any of their powers and discretions shall be subject to the previous consent of the settlor or some other person, whether named as protector, nominator, committee or any other name; and if so provided in the instrument creating the trust the trustees shall not be liable for any loss caused by their action if the previous consent was given.

(2) There may be conferred on the settlor or some other person, whether named as protector, nominator, committee or by any other name, by the instrument creating the trust, any powers, and without limitation to the foregoing power may be conferred on that person to do any one or more of the following:

(a) determine the law of which jurisdiction shall be the proper law of the trust;

(b) change the forum of administration of the trust;

(c) remove trustees;

(d) appoint new or additional trustees;

(e) exclude any beneficiary as a beneficiary of the trust;

(f) include any person as a beneficiary of the trust in substitution for or in addition to any existing beneficiary of the trust; and

(g) withhold consent from specified actions of the trustees either conditionally or unconditionally.

(3) A person exercising any of the powers set forth in paragraphs (a) to (d) and (g) of subsection (2) shall not by virtue only of the exercise of the power be deemed to be a trustee; and unless otherwise provided in the instrument creating the trust, is not liable to the beneficiaries for the bona fide exercise of the power.”

The Virgin Islands Special Trusts Act, 2003

The Virgin Islands Special Trusts Act, 2003 (or “VISTA”) came into force on March 1, 2004. This statute considerably enhances the provisions of s. 86 of the Trustee Act by enabling the settlor to prevent the assets, and underlying assets, of the trust from being sold without his agreement and enabling him to have control over investment and administrative matters in his capacity as the director of an underlying company.

Features of VISTA

Some of the features of the 2003 Act are as follows:

(a) The Act does not apply to BVI trusts generally: it only applies where there is a provision in the trust instrument directing the Act to apply.

(b) Where VISTA applies, designated shares will be held on “trust to retain” and the trustee’s duty to retain the shares as part of the trust fund will have precedence over any duty to preserve or enhance their value. The trustee will not therefore be liable for the consequences of holding (rather than disposing of) the shares.

(c) The Act specifies that (unless the trust instrument provides otherwise) the trustee is permitted to dispose of designated shares in the management or administration of the trust fund, but can only do so with the consent of the sole director or the directors of the company (and/or that of such persons as are specified in the trust instrument).

(d) The Act specifies that, subject to any contrary provisions in the trust instrument, unless the trustee is acting on an “intervention call” (as defined in the Act), the trustee may not exercise its voting or other powers so as to interfere in the management or conduct of any business of the company; the management or conduct of the company’s business will be left to those appropriate to deal with it, namely its sole director or its directors, whose fiduciary duties to the company will remain intact, except to the extent that the trustee/shareholder is refrained qua trustee from exercising some of the powers of a shareholder.

(e) The statute also provides that the trust instrument may include “office of director rules” specifying how the trustee must exercise its voting powers in relation to appointment, removal and remuneration of directors, and the trustee is generally required to follow those rules. Except in compliance with those rules, the trustee must generally take no steps to procure the appointment or removal of the company’s directors.

(f) The Act further provides that the trust instrument may specify that the trustee may intervene in the affairs of the company in specified circumstances, i.e. when required to do so by an “intervention call” by a beneficiary, an object of a discretionary power of appointment, a parent or guardian of either of them, the Attorney General (in relation to charitable trusts), the enforcer (in relation to purpose trusts) or other specified persons.

(g) The statute contains provisions enabling beneficiaries, directors and others to apply to the court for enforcement of the terms of the Act and, on the application of a specified person, the court is empowered to authorise the trustees to sell designated shares where retaining them is no longer compatible with the wishes of the settlor.

(h) The rule in Saunders v Vautier will not apply (for a maximum of 20 years) to VISTA trusts where such rule has been expressly excluded by the trust instrument.

(i) The Act is confined to shares in BVI companies, but there is no reason why shares in non-BVI companies (or other assets) should not be held by a BVI company to which VISTA applies if it is the intention that those assets should (effectively) be held subject to a VISTA trust. Typically shares in non-BVI companies and/or other assets are held by the BVI company the shares of which are held by the trustee of the VISTA trust. VISTA then prevents the trustee from being able to procure a disposal of underlying assets or from being able to engineer an intervention in the affairs of controlled subsidiaries.

(j) The trustee of a VISTA trust must be a company which holds a licence to undertake trust business under the Banks and Trust Companies Act, 1990.

Applications for VISTA in the context of reserved power trusts

Especially since the sole director (or one of the directors) of the underlying company might be the settlor, the applications for VISTA trusts in the context of settlor reserved power trusts include the following:

(a) The classic situation for considering the establishment of a VISTA trust is where shares in private companies, and, in particular, shares in trading companies, are to be held in trust.

VISTA will ensure that the trustee will be unable to sell the shares without the approval of the sole director (who might be the settlor) or the directors (who might include the settlor or be those chosen by her) and/or such other approval (such as that of the settlor) as is made requisite by the trust instrument. It will also ensure that the company can be managed by those who are qualified to run it, namely its directors, without trustee intervention (and, in particular, without the threat that the company’s directors might be removed) save in specified situations.

The “office of director rules”, which are referred to above, effectively enable the trust instrument to provide a succession mechanism for the appointment of directors of the underlying company, so that those family members or others whom the settlor wishes to do so can become directors and can manage the company largely free from interference and, in particular, threat of removal at the appropriate time (e.g. following the death, resignation or incapacity of the settlor).

(b) A VISTA trust should also be considered, inter alia, whenever the settlor is reluctant to hand over responsibility for administrative or managerial matters to a trustee.

Many settlors feel especially uncomfortable about giving up control over investment decisions. One solution adopted in the past was to arrange for the settlor to be appointed as the trustee’s investment adviser, but this approach is nowadays generally thought unwise in the light of a trustee’s duties in relation to the appointment of such an adviser and the monitoring of his performance.

A better solution, following the enactment of VISTA, has been for a structure to be set up which enables the settlor to retain these functions as, say, the sole director of a company, the shares of which are held by the trustee of a VISTA trust. The settlor is then able to retain sole managerial responsibility at the director level, essentially without trustee intervention. Alternatively the settlor could be appointed as the company’s investment adviser. This control can then be transferred to chosen family members and/or others at the relevant time, pursuant to the “office of director rules” which are referred to above.

(c) Similarly a structure involving VISTA is often used for holding assets which would otherwise be regarded inappropriate for a trust (or as underlying trust assets) – for example, ships, aeroplanes, and investments which involve an inappropriate amount of risk (such as futures, options, and assets of a commercial nature). A VISTA structure is also appropriate where the settlor requires funds to be invested in accordance with the principles of Sharia law.

The relevant assets would be held by a company, the shares of which (or the shares of the holding company of which) would be held by a trustee of a VISTA trust. The trustee, being essentially denuded of its powers of intervention (and of the risks associated with non-intervention), would not, then, be required to exercise its shareholder-powers to ensure that the trust fund is appropriately invested. As we have seen the director or directors of the underlying company (who might be or include the settlor) would effectively have sole responsibility for the manner in which the company’s assets are invested and can therefore ensure that the trust’s underlying assets are invested in accordance with the settlor’s requirements.

(d) As has been indicated, VISTA obliges the trustee to hold shares on “trust to retain”. If, therefore, it is imperative from the settlor’s perspective that particular assets (which she does not regard as mere “impersonal investments”) should not be disposed of by a trustee, i.e. in the exercise of its administrative powers and duties, then consideration should be given to transferring these assets to a company and establishing a VISTA trust over the shares of the company in question (or its holding company). The trustee would be prevented from disposing of the shares unless, say, the consent of the director or directors (which might be or include the settlor), and/or others specified in the trust instrument (such as that of the settlor), is obtained.

A VISTA trust might therefore be appropriate for family heirlooms or other assets (such as shares in family companies) which the settlor requires to remain in trust until these are distributed in specie to family (or other) beneficiaries in accordance with the trust’s dispositive provisions and which, from the settlor’s viewpoint, should not be sold and reinvested, at least whilst these are still held in trust.

There is therefore immense scope for the reservation of administrative and managerial powers to settlors under the VISTA legislation. In the case of the settlor who also wishes to have a substantial amount of control over the exercise by the trustee of its dispositive powers, there should be no reason why the settlor could not, in the trust instrument, reserve to herself a power of revocation and a general power of appointment, the power to replace the trustee, or a power of veto over the exercise by the trustee of its powers of appointment over capital: as we have seen in part 1 of this article, the reservation to the settlor of such powers is permitted under the general principles of English law which, inter alia, apply in the BVI.

The Cayman Islands

Part III of the Trusts Law (2001 Revision) creates a presumption of lifetime effect and also provides that specified powers may be reserved to the settlor of a Cayman Islands trust.

Part III of the Trusts Law (2001 Revision) provides as follows:

“13. (1) In construing the terms of any instrument stipulating the trusts and powers in and over the property, if the instrument is not expressed to be a will, testament or codicil and is not expressed to take effect only upon the death of the settlor, it shall be presumed that all such trusts (and in particular the duty of the trustees to the beneficiaries to administer the trust in accordance with its terms) and powers were intended by the settlor to take immediate effect upon the property being identified and vested in the trustee, save as otherwise expressly, or by necessary implication, provided in the instrument.

(2) Subsection (1) shall apply notwithstanding-
(a) that the trust may have been created in order to avoid the application upon the settlor’s death of laws relating to wills, probate or succession;
(b) that during the lifetime of the settlor, beneficiaries of the trust may not be ascertainable;
(c) that beneficial interests may only vest in remainder or may remain contingent or subject to defeasance by the exercise of reserved powers or otherwise; or
(d) that the settlor may be one of the trustees.

(3) Subsection (1) does not apply in the case of a declaration by a person constituting himself the sole trustee of a property to which he was beneficially entitled.

14. (1) The reservation or grant by a settlor of a trust of-
(a) any power to revoke, vary or amend the trust instrument or any trusts or powers arising thereunder in whole or in part;
(b) a general or special power to appoint either income or capital of the trust property;
(c) any limited beneficial interest in the trust property;
(d) a power to act as a director or officer of any company wholly or partly owned by the trust;
(e) a power to give binding directions to the trustee in connection with the purchase, holding or sale of the trust property;
(f) a power to appoint, add or remove any trustee, protector or beneficiary;
(g) a power to change the governing law and the forum for administration of the trust; or
(h) a power to restrict the exercise of any powers or discretions of the trustee by requiring that they shall only be exercisable with the consent of the settlor or any other person specified in the trust instrument, shall not invalidate the trust or affect the presumption under section 13(1).

(2) In this Part-
“settlor” has the meaning ascribed to that term in section 87 .

15. A trustee who has acted in compliance with, or as a result of an otherwise valid exercise of, any of the powers referred to in section 14(1) shall not be acting in breach of trust.”

In the words of one leading Cayman Islands practitioner ,

“The rationale for introducing the legislation in Cayman was to try to introduce a measure of certainty for settlors, practitioners and the courts as to how many powers could be reserved by a settlor without a court saying that the settlor had not intended to create an inter vivos trust and that the instrument was testamentary. It seems to be generally agreed that each of the powers listed in section 14(1), on its own, would be valid and would not render the instrument testamentary as a matter of the laws of England or the Cayman Islands. Section 14(1) simply clarifies that if any of the powers listed in section 14(1) are reserved, the trust will not be invalidated nor affect the presumption under section 13(1). The presumption of lifetime effect is of particular importance in this context as it reverses the normal presumption so that if powers in excess of, or different to, those specified in section 14(1) are reserved, the presumption of lifetime effect will still operate to give a measure of certainty that the intention was to create an inter vivos trust rather than a testamentary disposition. Section 13(2)(a) also makes it clear that the presumption shall apply even if it can be shown that the trust was created in order to avoid probate on the death of the settlor.”

The Bahamas

Section 3 of The Bahamas’ Trustee Act, 1998 provides as follows:

“(1) The retention, possession or acquisition by the settlor of any one or more of the matters referred to in sub-section (2) shall not invalidate a trust or the trust instrument or cause a trust created inter vivos to be a testamentary trust or disposition or the trust instrument creating it to be a testamentary document.

(2) The matters referred to in subsection (1) are -
(a) any powers to revoke the trust or the trust instrument or any trusts or powers granted thereby, or to withdraw property from the trust;
(b) any powers of appointment or disposition over any of the trust property;
(c) any powers to amend the trust or the trust instrument;
(d) any powers to appoint, add or remove any trustees, protectors or beneficiaries;
(e) any powers to give directions to trustees in connection with the exercise of any of their powers or discretions;
(f) any provisions requiring the consent of the settlor to any act or abstention of trustees;
(g) any such other powers as are referred to in subsection (2) (a) to (h) of section 81 ;
(h) the appointment of the settlor as a protector of the trust;
(i) any beneficial interests of the settlor (including absolute beneficial interests) in the capital or income of the trust property or in both such capital and income; and
(j) any interest of the settlor in any companies or assets underlying the trust property and any control of the settlor over such companies or assets.

(3) Subject to any contrary intention expressed in the trust instrument and subject to its other terms, a power in a trust instrument to amend, alter or vary a trust shall include (without limitation) a power to add as beneficiaries any persons whatever (including the settlor and any private or charitable trusts or foundations) and to remove any beneficiaries.”

Section 81 (2) of the Trustee Act is worded as follows:

“(2) The trust instrument may confer on the settlor or on any protector any powers including (without limitation) power to do any one or more of the following-
(a) determine the law of which jurisdiction shall be the proper law of the trust;
(b) change the forum of administration of the trust;
(c) remove trustees;
(d) appoint new or additional trustees;
(e) exclude any beneficiary as a beneficiary of the trust;
(f) add any person (including the settlor and any private or charitable trust or foundation) as a beneficiary of the trust in addition to any existing beneficiary of the trust;
(g) give or withhold consent to specified actions of the trustee either conditionally or unconditionally; and
(h) release any of the protectors’ powers”.

Although the statutory provisions of the Cayman Islands and The Bahamas which are set out in above contain many differences, the most significant differences would appear to be as follows:

(a) Section 3 of the Bahamian statute does not include a reference to a presumption of trusts and powers taking immediate effect.

(b) The provisions of paragraph (e) of s. 14 (1) of the Cayman Act and those of paragraph (e) of s. 3 (2) of The Bahamas Act are different. The former merely refers to “the power to give binding directions to the trustee in connection with the purchase, holding or sale of the trust property”, whereas the Bahamian provision goes much further by referring to “any powers to give directions to the trustees in connection with the exercise of any of their powers or discretions” [emphasis added].

(c) The Cayman statutory provision does not include the (remarkably) wide provisions of paragraph (i) of s. 3 (2) of The Bahamas Act: these would appear, on the face of them, to provide that a Bahamian trust would not be testamentary even if the settlor is absolutely entitled to both capital and income.

As a consequence, whilst the Bahamian provisions are potentially more far reaching than the Cayman provisions, care would need to be taken if the former are to be used to the full extent which the statute would appear, on the face of it, to permit: in addition to advice from Bahamian lawyers, advice from lawyers from other jurisdictions (such as jurisdictions in which the assets of the trust are situated) should therefore be obtained in order to ensure that the terms of a trust which reserves the relevant powers would be recognised as being fully effective under the laws of those jurisdictions. That said, it should go without saying that, since s. 3 of the 1998 Act is merely permissive, the trust instrument need not in any event reserve all the powers which are referred to in that section to the settlor.

The island of Nevis

Section 47 of the Nevis International Exempt Trust Ordinance 1994 is worded as follows:

“An international trust shall not be declared invalid or be affected in any way if the settlor, and if more than one, any of them either, -
(a) retains, possesses or acquires power to revoke the trust;
(b) retains, possesses or acquires power to amend the trust;
(c) retains, possesses or acquires any benefit, interest or property from the trust;
(d) retains, possesses or acquires the power to remove or appoint a trustee or protector;
(e) retains, possesses or acquires the power to direct a trustee or protector on any matter;
(f) is the beneficiary of the trust solely or together with others.”

Whilst the provisions of s. 47(e) and (f) would, on the face of them, appear to be surprisingly wide, the statutory provision as a whole is not anywhere near as comprehensive as the equivalent provisions of the Cayman Islands and The Bahamas statutes which are set out above and the utmost care would need to be taken in relation to its use.

The Cook Islands

Section 13 C of the Cook Islands International Trusts Act 1984 was inserted into that Act by s. 12 of the International Trusts Amendment Act 1995-6. The new section is worded as follows:

“An international trust and a registered instrument shall not be declared invalid or a disposition declared void or be affected in any way by reason of the fact that the settlor, and if more than one, any of them, either -
(a) retains possesses or acquires a power to revoke the trust or instrument;
(b) retains possesses or acquires a power of disposition over property of the trust or the subject of the instrument;
(c) retains possesses or acquires a power to amend the trust or instrument;
(d) retains possesses or acquires any benefit interest or property from the trust or any disposition or pursuant to the instrument;
(e) retains possesses or acquires the power to remove or appoint a trustee or protector;
(f) retains possesses or acquires the power to direct a trustee or protector on any matter;
(g) is a beneficiary trustee or protector of the trust or instrument either solely or together with others.”

The comments which are made above in relation to the Nevis, are equally applicable to sub-sections (b), (f), and (g) of s. 13C of the Cook Islands Act.

Jersey

Jersey is the most recent jurisdiction to have introduced reserved powers legislation. The Trust (Jersey) Law 1984 was amended by the Trusts (Amendment No. 4) (Jersey) Law 2006 to provide, in the new article 9A, as follows:

"(1) The reservation or grant by a settlor of a trust of –

(a) any beneficial interest in the trust property; or
(b) any of the powers mentioned in paragraph (2),
shall not affect the validity of the trust nor delay the trust taking effect.

(2) The powers are:-

(a) to revoke, vary or amend the terms of a trust or any trusts or powers arising wholly or partly under it;
(b) to advance, appoint, pay or apply income or capital of the trust property or to give directions for the making of such advancement, appointment, payment or application;
(c) to act as, or give binding directions as to the appointment or removal of, a director or officer of any corporation wholly or partly owned by the trust;
(d) to give binding directions to the trustee in connection with the purchase, retention, sale, management, lending, pledging or charging of the trust property or the exercise of any powers or rights arising from such property;
(e) to appoint or remove any trustee, enforcer, protector or beneficiary;
(f) to appoint or remove an investment manager or investment adviser;
(g) to change the proper law of the trust;
(h) to restrict the exercise of any powers or discretions of a trustee by requiring that they shall only be exercisable with the consent of the settlor or any other person specified in the terms of the trust.

(3) Where a power mentioned in paragraph (2) has been reserved or granted by the settlor, a trustee who acts in accordance with the exercise of the power is not acting in breach of trust.

(4) The States may make Regulations amending paragraph (2)."

The new s. 9A is in many respects very similar to the reserved powers legislation of the Cayman Islands and The Bahamas which is analysed above, but there would nevertheless appear to be significant differences. In particular, there is in the new Jersey legislation no equivalent to the corresponding provisions of the Cayman Islands' and The Bahamas' statutory provisions to the effect that the reservation of the powers in question will not cause a trust to be regarded as testamentary. Moreover s. 9A (3) of the Jersey Act is potentially much more far reaching than the exoneration which is contained, say, in s.15 of the Cayman statute: the ambit of the exoneration which s. 9A (3) of the Jersey Law provides has already been the subject of academic commentary.

Guernsey

At the time of writing Guernsey does not have any legislative provisions on settlor reserved powers, but recently a working group of professionals in that jurisdiction produced a Final Report on recommended changes to its Trust Law. This Report recommended the enactment of legislation along the lines of section 14 of the Cayman Act (analysed above).

Reservation of powers to enforce trusts
A settlor may of course be a beneficiary of a trust and as such will usually have the power to enforce it.

Under Cayman's "STAR" trusts legislation the power to enforce such a trust is capable of being (solely) reserved to the settlor in his capacity as the trust's enforcer and the retention of such a power is also possible in the case of a trust which is formed, e.g. under section 84 A of the BVI's Trustee Act.

Conclusion

The above overview of the different statutory provisions of various international finance centres is intentionally general in scope and is not a substitute for legal advice. Taxation advice from advisers in the relevant jurisdictions should always be obtained when an overseas trust is established: the reservation of powers to settlors can sometimes be ill-advised for tax reasons. When an overseas trust is established it is also imperative that advice from a lawyer who specialises in advising on the trust laws of the relevant jurisdiction should be obtained.

VISTA TRUSTS

Background: the problem which the Virgin Islands Special Trusts Act addresses

The trust has always been regarded as one of the best “succession vehicles,” but its use to cater for the succession of shares in companies has historically been impeded by a rule of English trust law (the “prudent man of business rule”) which is designed to help preserve the value of trust investments. This rule has traditionally made the trust an unattractive vehicle to hold assets which settlors intend trustees to retain. Another aspect of the rule effectively requires trustees to monitor and intervene in the affairs of underlying companies (as the English decisions Re: Lucking’s Will Trusts and Bartlett v Barclays Bank Trust Co Ltd made clear); this also creates difficulties both from the settlor’s standpoint and from that of the trustees.

The prudent man of business rule imposes on trustees the obligation to monitor the conduct of the directors and to intervene where necessary (e.g. to prevent the company entering in to an unduly speculative venture). It also places on them the requirement to exploit the shareholding to maximum financial advantage which may involve, e.g., accepting a financially attractive takeover bid for the company irrespective of the wishes of the settlor and an obligation to look for opportunities of spreading the financial risk by diversification, which may involve a sale of the company or its underlying assets. These obligations conflict with the wishes of the typical owner of a family business and have hitherto raised significant difficulties for trustees holding shares in such a business.

There is an inherent conflict between the prudence required of trustees and the entrepreneurial flare and quick decision taking required to run a successful business and most settlors find equally unwelcome the prospect of a compulsory sale of shares merely to satisfy short-term financial considerations. Professional trustees rarely have, or can be expected to have, the skills relevant to the particular business, and the monitoring procedures necessary to ensure that trustees avoid exposure to claims against the trustees often adds substantially to the cost of trust administration. Furthermore professional indemnity insurance for trustees may be or become problematic or prohibitively expensive.

Family businesses typically carry a significantly greater degree of financial risk than a well spread investment portfolio and diversification, which may become a priority for the trustees, will often be in direct conflict with the settlor’s wishes. To many settlors and their families, on the other hand, the self-managed company represents much more than an impersonal investment; among the factors which may figure in their thinking when contemplating a trust are: family tradition, social concerns for employees or the environment, career opportunities for descendants, and business projections looking further ahead than the long or medium term. Moreover the owner will often prefer to leave to the directors, rather than to the trustee/shareholders, the question of whether the company expands, contracts, or even goes out of business. Running the company to enhance the value of its shares will not necessarily be (and often is not) in its long term best interests, and economic commentators have pointed out that some of most successful companies are those whose owners have remained at the helm and which have not simply been run (and the shares of which have not been disposed of) purely for short term gain.

Thus trustees have faced the prospect of being squeezed between, on the one hand, exposure to potential liability for failure to dispose of shares and, on the other hand, settlor pressure to retain.

The Virgin Islands Special Trusts Act, 2003

A number of possible non-legislative solutions to these difficulties, such as the “non intervention” clause in trust instruments, requirements for consent and complex structuring (e.g. involving voting and non-voting shares), have been put forward, but all of these suffer from significant drawbacks.

The Virgin Islands Special Trusts Act, which came into force on 1 March 2004, now enables special new trusts, which are known as VISTA trusts, to be created which circumvent these difficulties.

The Act enables a shareholder to establish a trust of his company that disengages the trustee from management responsibility and permits the company and its business to be retained as long as the directors think fit. This is achieved in general terms by: first, authorising the entire removal of the trustee’s monitoring and intervention obligations (except to the extent that the settlor otherwise requires); secondly, by permitting the settlor to confer on the trustee a role more suited to a trustee’s abilities, namely a duty to intervene to resolve specific problems; thirdly, by allowing trust instruments to lay down rules for the appointment and removal of directors (so reducing the trustee’s ability to intervene in management by appointing directors of its own choice); fourthly, by giving both beneficiaries and directors the right to apply to the court if trustee fails to comply with the requirements for non-intervention or the requirements for director appointment and removal; and, lastly, by giving to the trustee, if required, the power to sell the shares with the consent of the directors.

Some of the features of the new Act are as follows:

· The Act does not apply to BVI trusts generally: it only applies where there is a provision in the trust instrument directing the Act to apply.

· Where the Act applies, designated shares will be held on “trust to retain” and the trustee’s duty to retain the shares as part of the trust fund will have precedence over any duty to preserve or enhance their value. The trustee will not therefore be liable for the consequences of holding (rather than disposing of) the shares.

· The Act specifies that (unless the trust instrument provides otherwise) the trustee is permitted to dispose of designated shares in the management or administration of the trust fund, but can only do so with the consent of the directors of the company (and/or that of such persons as are specified in the trust instrument).

· The Act specifies that, subject to any contrary provisions in the trust instrument, unless the trustee is acting on an “intervention call” (as defined in the Act), the trustee may not exercise its voting or other powers so as to interfere in the management or conduct of any business of the company; the management or conduct of the company’s business will be left to those appropriate to deal with it, namely its director or directors, whose fiduciary duties to the company will remain intact, except to the extent that the trustee/shareholder is refrained qua trustee from exercising some of the powers of a shareholder.

· The statute also provides that the trust instrument may include “office of director rules” specifying how the trustee must exercise its voting powers in relation to appointment, removal and remuneration of directors, and the trustee is generally required to follow these rules. Except in compliance with these rules, the trustee must generally take no steps to procure the appointment or removal of the company’s directors. The rules effectively enable settlors to create a succession mechanism for directorships.

· The Act further provides that the trust instrument may specify that the trustee may intervene in the affairs of the company in specified circumstances, i.e. when required to do so by an “intervention call” by a beneficiary, an object of a discretionary power of appointment, a parent or guardian of either of them, the Attorney General (in relation to charitable trusts), the enforcer (in relation to purpose trusts) or other specified persons.

· The statute contains provisions enabling beneficiaries, directors and others to apply to the court for enforcement of the terms of the Act and, on the application of a specified person, the court is empowered to authorise the trustees to sell designated shares where retaining them is no longer compatible with the wishes of the settlor.

· The rule in Saunders v Vautier will not apply (for a maximum of 20 years) to VISTA trusts where such rule has been expressly excluded by the trust instrument.

· The Act is confined to shares in BVI companies, but there should be no reason why shares in non-BVI companies (or other assets) should not be held by a BVI company to which VISTA applies if it is the intention that those assets should (effectively) be held subject to a VISTA trust.

· The trustee of a VISTA trust must be a company which holds a licence to undertake trust business under the Banks and Trust Companies Act, 1990. There is no requirement that such a company must be a BVI company (although, in general, it will be) or for it to administer trusts from, or have a physical presence in, the BVI.

· The company law duties of directors remain unchanged and the Act does not in any way alter the restraints placed on directors and others by criminal law. (Most types of BVI companies may have a sole director.)

When would a VISTA trust be appropriate?

Serious consideration should be given to the establishment of a VISTA trust in the following circumstances:

· When the settlor wishes to retain control, since matters can, if appropriate, generally be structured so that settlor–control can be retained at the director (company) level.

· When the settlor intends the shares which he wishes to settle on trust and/or the underlying assets of the company to be retained.

· When trustee involvement in the underlying company’s affairs is undesirable or inappropriate.

· Where charitable or non-charitable purpose trusts are needed for securitisations and off-balance sheet transactions. (See Walkers’ summary of the BVI’s new purpose trusts legislation.)

· Where the underlying assets of the trust are to comprise of speculative investments or investments which involve a degree of risk which would otherwise be regarded as inappropriate for the trustees of a non-VISTA trust.

Typically shares in non-BVI companies and/or other assets are held by a BVI company, the shares of which are held by the trustee of the VISTA trust. VISTA then prevents the trustee from being able to procure a disposal of underlying assets, or from being able or required to engineer an intervention in the affairs of controlled subsidiaries.

The enactment of this new statute, which is consistent with the historical development of the trust, and which was developed in close collaboration between the BVI government and the private sector, demonstrates that the BVI is in the forefront of those jurisdictions which are able to introduce innovative measures which meet the legitimate needs of their international clientele. It provides opportunities for many individuals who would otherwise wish to set up trusts to hold shares in their companies, but who have hitherto felt disinclined to do so as a result of the rigidity of the “prudent man of business” rule. It also provides opportunities for settlors who wish to retain control over investment and managerial aspects of a structure involving a trust.

For further information on VISTA trusts please contact Christopher McKenzie at christopher.mckenzie@walkersglobal.com.

This paper is general in scope and is not intended to be comprehensive. It is not a substitute for legal advice.

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