Trusts in ESOP and SIP arrangements
There has been a marked increase in the use of offshore trusts as vehicles for international employee share option and share incentive plans (share plans) particularly in the Middle East, the Far East and India. That increase seems to be caused largely by the growth of the economies in those regions in recent years, coupled with the fact that fewer tax and regulatory hurdles exist in those jurisdictions (compared to the US and the UK, for example, where similar plans are typically onshore structures driven by tax and regulatory considerations). Employers therefore have greater flexibility. A secondary driver of that growth is the sheer number of companies incorporated in the Cayman Islands and the British Virgin Islands – some 521,692 active companies at the last count.1
This article explores the role played by trusts in these types of plans, the reasons for choosing one type of trustee over another and compares Cayman and BVI as possible jurisdictions.
Structuring considerations – why use a trust?
There is no need to use a trust for a share plan: one can simply provide for a contract between the company and the relevant employees to whom shares (or options) are to be issued.
So why use trusts?
There are three principal advantages.
(i) Trust law rights and remedies
The employees become beneficiaries of a trust with all the rights and remedies (both personal and proprietary) that entails, in addition to any contractual rights.
(ii) A convenient vehicle to hold the company’s shares
There are two potential benefits. The first is that it allows the trustee to acquire shares from other shareholders and to transfer shares to employees as an alternative to the company having to issue further shares. That avoids possible dilution of existing shareholdings, the need for board resolutions authorising the issue of further shares and, in the case of listed companies, the need to seek relevant authorisations to admit the further shares to the relevant exchange. The second is that it provides a convenient vehicle for the acquisition of shares from employees (e.g. under pre-emption rights upon transfers of shares or cessation of employment). This avoids the potentially onerous legal procedure and expense of the company having to purchase its own shares in those circumstances.
(iii) Ring-fencing of shares
It may also give greater comfort to the employees who would otherwise be relying on the company issuing shares on each occasion on which an obligation to do so arose. With a trust, the shares are issued to the trustees at the outset to hold on the terms of the plan.
Consideration will also need to be given as to whether an investment holding company is needed to hold the shares (and any other trust assets) to limit the trustees’ liability to third parties. Professional trust companies will often require one, as will professional individual trustees, although trustees of a BVI trust may take some comfort from the statutory limitations on liability (as to which see below). This may well be another factor to consider in the choice of trustees.
Choice of trustees
There are no restrictions on the identity or number of the trustees of a trust governed by either Cayman or BVI law. There are three main options:
These could be directors or other senior executives of the company, with or without the addition of a professional trustee.
The main advantage is low cost (assuming that they will not be paid), although some (or all) of that is obviously lost if a professional is appointed.
The main disadvantages are:
- that it is an onerous responsibility for the individual trustees;
- the trustees have personal liability (both for debts to third parties and in relation to potential claims from beneficiaries for breach of trust) as a trust does not have separate legal personality (but see below regarding limited liability for BVI trusts)
- a lack of knowledge and expertise in relation to the administration of trusts (although this can be mitigated by the appointment of a trust professional as one of the trustees, but with cost implications).
If a Cayman STAR2 trust is the preferred vehicle (as to which see below) it must have either a licensed trust company or a registered private trust company as the sole trustee or one the trustees.
(ii) Professional trust company
The principal advantages are that the responsibility and potential liability is shifted to a professional trust company and that it will (if an appropriate trustee is chosen) have the necessary knowledge and expertise to administer the trust. That should also give some additional comfort to the employees who are beneficiaries (or potential beneficiaries) of the plan that it will be administered properly for their benefit.
The principal disadvantage is the cost, i.e. the trustee’s remuneration.
Control by the company can still be maintained by including appropriate provisions in the trust deed, including:
- powers to remove and appoint trustees;
- powers to determine which employees are transferred shares by the trust; and
- (if relevant) power to direct the trustee as to the investment of any trust assets other than shares in the company.
Those powers can be given to the company itself. In practice, they are often delegated to a remuneration committee or similar body appointed by the board of directors of the company.
(iii) Private trust company
A private trust company (PTC) is one which is incorporated by the company specifically to act as trustee. It can be a wholly-owned subsidiary of the company and the directors can, therefore, be any persons appointed by the company (and can be directors and/or other senior executives of the company). PTCs can be incorporated both in Cayman and in BVI without any licensing requirement.
It avoids the problems of the personal liability of individual trustees. It can also simplify the documentation, as it gives direct control to those who are making the decisions (as opposed to the use of a professional trustee, in which additional mechanisms are required to give control back to the company itself (see paragraph (ii) above)). To ensure that there is sufficient trust expertise available to the board, a trust professional can also be appointed as a director.
Cayman and BVI have much in common. They both have modern trust laws based on English common law, a court system in which the ultimate appeal court is the Privy Council in London, established and experienced international law firms and trust companies, ‘no tax’ regimes and the absence of reporting requirements concerning trust assets or income.
Other things being equal, it will generally be better to have the same law governing the trust (i.e. a BVI law trust (and BVI trustee) if the shares it will hold are shares in a BVI company), but there are some technical differences that can tip the balance in favour of one jurisdiction over the other.
Cayman has STAR trusts. One unique feature of STAR is that it allows the company to specify which beneficiaries are entitled to what information (provided there is an effective enforcement mechanism), so in a situation in which the company wants the shares to be retained in the name of the trustee and to ensure that employees do not know what shares have been awarded to other employees, STAR trusts can make sure that they do not have access to that information. Under an ordinary trust, the position is not entirely clear.
On the other hand, a possible advantage of a BVI trust is that, if an appropriate provision is included in the trust instrument, a trustee is not personally liable under a contract if, broadly speaking, the third party knows it is acting as a trustee and has otherwise acted properly.
Documentation and funding
There are two principal documents, which are as follows.
(i) Plan rules
These set out the mechanics relating to the grant and exercise of options, the exercise price and lapse or cancellation of options in the case of a share option plan. In the case of a share incentive plan, the rules specify the criteria to be satisfied prior to transfers of shares to eligible employees. Provisions relating to changes in capitalisation, dissolution, application of a scheme of arrangement or similar event are typically included in both cases.
One point to watch is that ‘vesting’ means different things in different contexts. In the ESOP context, for example: in the UK, it usually refers to the point where the option becomes exercisable; whereas in the US, it will normally mean the point when the share ownership crystallises. In an international context, it does therefore need to be carefully defined.
(ii) Trust deed
This sets out the respective rights and obligations of the company, the trustees and optionholders/eligible employees. The trustees will typically require an indemnity from the company in their favour and other protections to limit their liability. Reduction in the amount of discretion afforded to the trustees (for most trustees) and the maintenance of control by the company (as far as it is concerned) will be of key importance.
The company will normally want the trust’s shares to be fully paid, so it will need to fund the trust with sufficient cash to subscribe for them. That will also need to be documented, either by way of a deed of gift or loan agreement or similar documentation, as appropriate.
Both Cayman and BVI have flexible and sophisticated trust regimes and are frequently used in international Share Plans. The choice of jurisdiction is often made simply because of the jurisdiction in which the company is incorporated with no particular reason to use one over the other, but it is worth giving it some consideration, as there are occasionally circumstances in which one of them has a distinct advantage.
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