Potential restrictions - Swiss and Russian legislation on transfers into trust

Tuesday, 01 February 2011
Ekaterina Butler looks at the potential restrictions of Swiss and Russian legislation on transfers into trust.

This article considers potential restrictions imposed under Russian or Swiss legislation on the transfer of ownership of assets into trust by way of lifetime gifts, whether arising from marital property regime or inheritance rights.

It is assumed that: the settlor, their spouse and next of kin are Russian residents; the assets (before and after transfer into trust) are movable property located in Switzerland; and a spouse is an excluded beneficiary.

Marital property regime

Switzerland

Under Swiss law, the fall-back regime (i.e. in the absence of any contrary agreement between the spouses) is that of ‘contribution to jointly acquired property’ or ‘accumulated property’. Under this regime, art. 201 of Swiss Civil Code (SCC), a spouse is generally entitled to dispose freely of their property, subject to statutory provisions.

The issue is whether, within the ‘accumulated property’ regime, a spouse who is not a beneficiary of the trust can challenge the transfer by the other spouse of certain property into trust.

In the event that the property settled into trust is considered as property jointly acquired during the marriage property, article 208 SCC applies, permitting to add back to the acquired property the value of certain gifts if made out of acquired property. Such addition concerns (i) gifts made by the spouse within five years prior to the dissolution of the marital property regime without the consent of the other spouse, except for customary gifts or (ii) any divestments of assets undertaken by the spouse during the marital property regime with the intention of reducing the participation claim of the other.

In other words, if one spouse settles any jointly acquired property into trust with the intention of reducing the claim of the other spouse in the event of a divorce, the value of the settled property should be taken into account at the time of divorce.

Having said that, the addition mechanism provided for in art. 208 SCC does not affect the validity of the transfer. This means that the trust assets are not to be recovered unless the spouse transferor does not have sufficient means to compensate the other spouse.

Russia

Under Russian law, art. 34 of the Family Code of Russian Federation (FCRF), the fall-back regime is that of ‘joint property’, which is conceptually close to the Swiss ‘accumulated property’ marital property regime. All property (other than the property owned individually by the spouse prior to entering into marriage and the gifts and inheritance received during the marriage) acquired by the spouse in the course of marriage is deemed joint property.

Different, in comparison to Swiss law, is the fact that under art. 35 FCRF, any disposal of the joint property, as defined by the joint property regime, by one spouse cannot be made without the consent of the other spouse. Such consent is presumed. Moreover, transfers made without the consent of the other spouse may be found invalid by a judge upon application of the non-consenting spouse if it can be shown that the offeree knew, or should have known, about the default of the requisite consent.

In practical terms, such transaction is treated under Russian legislation as invalid on the grounds of excess of authority by virtue of art. 174 of Civil Code of Russian Federation (CCRF) with the consequence that the non-consenting spouse is entitled to make a claim for restitution, or compensation if restitution is impossible. The claim must be made within one year from the day when the claimant knew, or should have known, about the circumstances giving rise to the invalidity of the transaction.

It should be mentioned that the Russian legislation does not have an article equivalent to the ‘addition to the acquired property’ article of the SCC.

Nonetheless, according to the current practice of the Russian courts (see Arbitration Court of Moscow, Decision dated 5 February 2008, N A40-56141/07-125-368), where the offeree was aware of the existence of the other spouse, but did not know anything about the dispute between the spouses with respect to their property, the court found that ‘it is reasonable and in accordance with common business practice to expect that the offeree should inquire about the possibility of a lack of consent of the other spouse.’

The trustee of our hypothetical trust, where one spouse is an excluded beneficiary, should be particularly vigilant to avoid a situation whereby the trustee would be deemed to have known that the property settled into trust was joint property transferred without consent of the other spouse.

Conflict of law

Clearly, in this hypothetical case, where the spouses are residents of the Russian Federation and their marital property regime is governed by the law of the Russian Federation, while the trust assets are located in a third jurisdiction, there will be a conflict of law problem.

Consider a simple, but not uncommon, situation where the trust assets (and previously the private fortune of the spouses) are bankable assets located in a bank account in Switzerland. The rights of the non-consenting spouse (who is not a party to a deed of gift into trust) over the immovable property are governed, both under Russian and Swiss private international law rules, by the law of the place of location of the immovable property. However, as the cause of action arises out of spouse’s rights under the marital property regime, the law applicable to determining the rights of the spouse will be the law of the martial property regime, i.e. Russian law.

Even where the legislation of the trust jurisdiction has specific provisions protecting trust assets from a spouse’s community of property claim (based on the marital property regime applicable to the settlor), for example Cook Islands trust law, the effectiveness of such legislation depends on the willingness of judges in the place where the property is situate to enforce it.

Inheritance rights

A further restriction on the freedom of lifetime gifts is so-called ‘clawback’. This issue arises where forced heirship rules entitle the decedent’s children, parents, spouse or others to inherit a mandatory share of the decedent’s estate, irrespective of any directions to the contrary in the will, and where anti-avoidance rules bring gifts made before the death back into the estate from which the mandatory share is paid.

Some countries apply clawback to deathbed gifts made with the deliberate intention of flouting forced heirship rules and others also to lifetime gifts made many years before the death.

Switzerland

Under Swiss law, art. 471 SCC provides for a mandatory share of the decedent’s estate as follows:

  1. For a descendant, three quarters of his statutory right of succession
  2. For each of the parents, one half
  3. For the surviving spouse, the registered partner one-half.

Under art. 522 SCC, if the decedent has exceeded the disposable portion, the heirs not receiving the amount of their mandatory share may claim that the bequest be reduced to the permitted amount.

Clauses relating to the shares of statutory heirs are regarded as mere division rules if the disposition does not reveal another intent of the disposing person.

Under article 527 SCC, the legal heirs may demand abatement of the lifetime gifts if (i) they are revocable or (ii) the decedent has made them within five years before death, excluding customary gifts. In this respect, a gift to a revocable trust is considered a revocable gift.

Also subject to abatement are ‘the alienations of assets initiated by the disposing person with the obvious intent to evade the restrictions concerning mandatory shares’. This would be the case if the settlor decedent intended to use a trust structure to create a sham transaction for the sole purpose of taking the property out of their estate and avoid the forced heirship rules.

In order to determine whether the mandatory share of an heir is affected, one should include the assets of the estate-planning vehicle in the accounts of the estate and to compute whether the assets settled into trust encroach on the mandatory portion. If this is the case, the abatement will affect the gifts made to the trust.

There is an issue of enforcement of the heirs’ rights in order to get hold of the assets abroad where these assets are considered as lawful assets of the trust and the relevant legislation has anti-forced-heirship provisions.

Russia

The CCRF provides for a certain freedom of testamentary disposition, which is, however, limited by the forced heirship rules and a mandatory share of the legal heirs.

The following persons are entitled to the mandatory share of the decedent’s estate as per article 1149 CCRF, as follows.

  1. Minor or disabled children of the decedent
  2. Disabled spouse
  3. Disabled parents
  4. Disabled dependants had been dependants of the decedent at least for the one-year term preceding his/her death and resided together with him/her.

The mandatory share is one-half of the share to which the heirs would have been entitled in the case of succession by operation of law.

One should note that under Russian law, a person is deemed disabled (unable to work) if such person is a minor or has reached the official retirement age, which is 55 years for women and 60 years for men. A disabled person is also a person who has been recognised as an invalid (physically incapacitated).

In other words, the forced heirship rules will automatically cover minor children of the decedent as well as their spouse and/or parents who have reached the official retirement age.

Under articles 1110 et seq. CCRF the estate shall include all the assets of the decedent at the time of their death.

Similar to article 522 SCC, the article 1149 CCRF para. 2 provides that the right to a mandatory share in an estate shall be satisfied out of the residual part of the estate even if it is going to diminish the rights of other legal heirs to that portion of estate, and when the non bequeathed part of assets is insufficient to satisfy the right to mandatory share, out of the portion of assets that has been bequeathed.

By virtue of para 3, 1149 CCRF any mandatory share also includes any property over which fidéicommis (trust) is established by the will in favour of the heir. Further, not dissimilar to article 488 SCC, article 1160 CCRF prohibits a fidéicommis of a second order.

There are no provisions similar to the Swiss abatement and addition provisions.

However, the Comments to the CCRF provide that if a lifetime gift is made with the purpose of depriving the heirs of their mandatory share or without the intention of transferring the property rights, the provisions of article 170 CCRF regulating a sham transaction shall apply.

Article 170 CCRF renders any sham transaction null and void ab initio, on the one hand, but on the other hand as per the wording of this article the requirement of the sham is the intention of all the parties to the transaction.

There is little doubt that the trustee who knows that the settlor is setting up a trust in view of avoiding the Russian forced heirship rules is a party to a sham gift transaction within the meaning of the Russian legislation.

Conflict of law

Finally, the issue of conflict of law must always be borne in mind. If the assets of the trust are located in a jurisdiction that gives protection against forced heirship rules, it is probable that the courts of that jurisdiction will not enforce a Russian judgment. If the assets are located in a bank in Switzerland, however, the Swiss Private International Law Act will refer to the succession laws of Russia on the basis that where the cause of action arises out of heir’s rights under the succession law, the law applicable to determining such rights is the law of the estate, i.e. Russian law.

Where the legislation of the trust jurisdiction does have specific provisions protecting trust assets from a claim by an heir entitled under the succession laws applying to the deceased settlor, for example the Trusts (Guernsey) Law 2007, the effectiveness of such legislation depends on the willingness of judges in the place where the property is situate to enforce it.

In conclusion, trustees should be made attentive to the fact that lifetime transfers of property to common-law trusts established by residents of Russia whose marital regime and estate are subject to the laws of Russia over property located in Switzerland may be subject to restrictions arising precisely out of the marital regime or forced heirship rules to which Russian law will apply.

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Ekaterina Butler

Ekaterina Butler TEP is a paralegal at Lalive.

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