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 uncert