Pitfalls and solutions

Countries seeking to develop a successful ‘offshore’ trust industry usually adopt a deliberate policy of legislating to match demands for increasingly ‘user friendly’ structures and to offer distinct advantages. As Lord Walker put it in Schmidt v Rosewood: ‘These territories…are chosen not for their geographical convenience, but because they are supposed to offer special advantages in terms of confidentiality and protection from fiscal demands (and, sometimes, from problems under the insolvency laws or laws restricting freedom of testamentary disposition, in the country of the settlor’s domicile).’

New legislation is often demanded when there is a perception that it will create or increase offshore trust business. This led in many instances to the introduction of statutory recognition of reserved powers, protection from enforcement of certain kinds of foreign judgments and dramatically innovative concepts, such as the STAR trust in the Cayman Islands, or the VISTA trust in the BVI, designed to give life to trusts that allow unprecedented levels of control and flexibility. More recently, it has been the driving force leading to regulations allowing the use of unlicensed private trust companies.

The most successful structures, however, are those that take advantage of the innovative techniques available without undermining the core principles which validate the trust. In so doing, they avoid a number of common pitfalls. Some of these are discussed below.

Reserved powers

Most offshore jurisdictions have included in their legislation provisions that specify that the reservation or grant of certain powers will not invalidate a trust. The objective is to ensure that there is certainty about the form of trust that will be upheld under local law. There is a common misconception that the offshore jurisdictions are universal in their approach to reserved powers. This is not the case and often the differences are so subtle that they may not be appreciated.

By way of example, in the Bahamas and the BVI, it is permissible to include ‘any one or more’ of a wide-ranging list of powers (including, (a) to determine the proper law (b) change the forum for administration of the trust (c) exclude or add beneficiaries and (d) withhold consent to the exercise of the trustee’s powers, etc.). By contrast, in the Cayman Islands, a list of permitted powers is set out at section 14 of the Trusts Law (2007 Revision), but the list appears to be disjunctive, so that it is permissible to include either one or the other of the powers but arguably not all of them. A detailed comparison of the relevant legislation is advisable when deciding which jurisdiction is the better fit.

It is therefore never advisable to adopt a ‘one size fits all’ approach. Draftsmen and advisors should first consider carefully the requirements in each jurisdiction and whether they fit with the approach that will be taken to establishing the particular trust. Particular attention should be paid to the words of the applicable statute to ensure that it is carefully followed and applied. Whether or not there is a permissive statute, the question is whether, in reality, the arrangement will be viewed as one in which the trustee has no duties – or such minimal duties – so that it will be held to be a sham. It is also necessary to consider the vulnerability of the trust assets to attack on this basis in the lex fori if they are not held in the offshore jurisdiction (or through a company incorporated in that jurisdiction).

The inclusion of too many, or too wide-ranging, reserved powers should also be avoided. It is worth taking note of recent decisions of the Privy Council on appeal from the Isle of Man (Pattni v Ali [2006] UKPC 51), and the courts at first instance in the Cayman Islands (Bandone v Sol Properties Ltd May 2008, unreported) and in Jersey (Re Karinska and Greencap Limited [2006] JRC 152) confirming a change in the common law rule so that foreign non-monetary judgments (including in some instances judgments mandating that powers should be exercised in a particular way, or for the transfer of shares) can now be enforced at common law. In tandem with the foreign element provisions in many of the offshore jurisdictions, it could also be sensible to specify that certain powers are fiduciary, to ensure that their exercise must be scrutinised by the local court whenever there is a question about whether and how they must be exercised.

Protectors’ function poorly defined or too extensive

In the absence of legislation, or where the legislation simply provides that the protector can be given any one or more of a range of powers, the protector is really a ‘creature of the trust’ (Re Omar Family Trust [2000] WTLR 713) and can be given a role that is tailor-made to the terms of the particular trust. However, as protectors have grown in popularity, so have the difficulties associated with their role in managing and administering trusts. Often in recent years, the most protracted disputes in which offshore practitioners have been involved have had, at their heart, a difference of opinion between protector (or management committee or equivalent entity) and the trustee, or some doubt about the nature of the protector’s powers and the extent of the protector’s right to be involved in the management of the trust or in legal proceedings affecting the trust (a recent decision of the Grand Court of the Cayman Islands in Re Circle [2007] CILR 225 held that the protector’s costs associated with legal proceedings would not be met out of the trust if the protector chose to participate, because ‘there were no issues concerning his powers, rights or duties as a trust protector’).

Disputes can often be avoided by ensuring that there is a clear delineation of the protector’s functions and the nature of his powers and specifying clearly whether these are intended to be personal or fiduciary. Consideration should also be given to how extensive the protector’s role should be; it can often be effective to limit the protector simply to holding a power to remove and appoint trustees, combined with a right to receive relevant information in support of this monitoring function. Alternatively, the protector could have a role to play in relation to special companies or underlying investments only. Clauses specifying whether there are to be any limits on the protector’s right to an indemnity and/or ability to take legal advice and be represented in court proceedings at the expense of the trust fund should also be considered where necessary and appropriate.

When providing that a protector is to exercise powers in a fiduciary capacity, inadequate thought is usually given to how and by whom the exercise of these powers is to be policed. Many of the offshore statutes (or the deed itself) will provide that the trustee is excused from liability for acting on directions given to it by the exercise of powers granted under the reserved powers provisions (Section 15 of the Cayman Islands Trusts Law (2007 Revision) provides, for example, that ‘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, shall not be acting in breach of trust’). However, if the trustee is on notice of matters that could affect the propriety of the exercise of the power, it is unlikely to be reasonable for those matters simply to be ignored. For starters, the trustee must be satisfied that the powers have been validly exercised in order to rely on the statutory exoneration. In any event, a beneficiary would usually have standing to mount a challenge to the proposed exercise of the power. The safest course therefore, may be to avoid confusion by avoiding reliance on provisions that purport to rule out the need for any inquiry by the trustee into the exercise of fiduciary powers by other power holders.

STAR trusts and enforcement mechanisms

Cayman Islands STAR trusts have been described by many commentators as a useful way of drafting so as to avoid disputes, or to provide for the efficient disposal of disputes when they arise. The magic of the STAR regime for these purposes is the option that it provides for separating the beneficial interest(s) from the ability to enforce. However, accountability to someone with an interest (if not a duty) to enforce may be crucial to ensuring that the arrangement is safe from challenge, on the authority of the dicta of Millett LJ in Armitage v Nurse ([1998] Ch 241).This may be particularly important if any of the trust assets are vulnerable to attack outside of the Cayman Islands. Hence, arguably the enforcer (or at least one of the enforcers) should be a beneficiary or have fiduciary duties to enforce the trust.

Directors and private trust companies

When considering proposed appointments to the board of a private trust company (PTC), particular attention should be paid to whether it is intended also to grant powers under the trust to proposed directors in their individual capacity. This may often be the case where it is intended that family members should play multiple roles. It may be possible for a mechanism for dealing with conflicts to be incorporated into the structure; for example, delegating the dispositive powers of the PTC to a distribution committee made up on non-beneficiaries, requiring voting abstention, etc or waiving conflicts (if necessary and appropriate) in the Articles of the PTC and the deed. However, far from avoiding the risk of dispute, this may provide yet another issue to fight about. There is a strong case for ensuring the effective independence of the board of the PTC and ensuring that, so far as possible, individuals do not play dual roles.

Conclusion

The range of options available in many of the jurisdictions has constantly evolved in the search to find new ways of allowing settlors to exert control. The challenge is to keep pace with these developments so as to take advantage of the flexibility and certainty that they can offer, but to avoid over-reliance on these provisions and ‘products’. What is required instead is careful drafting keeping in mind the core principles.