Beware of what you think you want

Friday, 01 February 2013
Marcus Leese and Lara Mardell look at reserved powers trusts that allow settlors to continue to make various decisions about the trust property without risk of invalidating the trust.

‘Wealth will not survive the third generation’ is an old Chinese proverb that resonates strongly throughout much of Asia. Successful entrepreneurs here, perhaps even more than in other parts of the world, can benefit from structures enabling them to preserve and grow family wealth over multiple generations.

But in Asia there is often greater reluctance than elsewhere to setting up structures such as trusts, often due in part to a fear of losing control of hard-earned assets.

One answer is settlor-reserved powers trusts, allowed by various jurisdictions including the Cayman Islands, the British Virgin Islands, Jersey and Guernsey. These trusts allow settlors to continue to make various decisions about the trust property without risk, under those laws, of invalidating the trust.

Such trusts are a valuable planning tool, but case law suggests that settlors need to think carefully about the amount of control they really need, and in particular whether they need to be able to revoke the trust.

Power is property

The Privy Council case of TMSF v Merrill Lynch [2011] UKPC 17 held that the settlor’s unfettered power to revoke meant the trust could be treated as his property and could be claimed by the settlor’s bankruptcy receivers for the benefit of his creditors. With many trusts established with some form of asset protection in mind, the retention of such a power can therefore undermine one of the key benefits of the structure.

Trust is a resource

In the English divorce case Charman v Charman [2006] EWHC 1879 (Fam) the court considered whether the assets in a discretionary trust settled by the husband, ostensibly for the benefit of himself and his family, could be considered to be part of his ‘financial resources’ for divorce purposes. The court held that the test was whether, if the husband were to ask the trustee to advance the whole (or part) of the trust capital to him, the trustee would be likely to do so.

Even non-reserved powers trusts could be at risk from this principle, if there is evidence that the trustee routinely complies with the settlor’s requests for funds. However, without an express power to require the trustee to hand over capital, the settlor will at least have an argument that the trust is not their financial resource. With that power, they will not have such an argument in a divorce case.

The alternative

With such risks, settlors and trustees may be tempted to create a trust with no express reservation of powers, but where they understand that the settlor will in fact control matters. Such an arrangement risks being held to be a sham, and therefore being disregarded for all purposes.

The key modern case on this is the Jersey case of Abdel Rahman v Chase Bank (CI) Trust Co Ltd [1991] JLR 103. This concerned a trust in which the settlor exercised essentially full control of the trust and its assets. The facts were extreme. On many occasions, for example, the settlor withdrew substantial funds from the trust fund without the knowledge of or, it appeared, any subsequent complaint by the trustee.

The Court held that the trust was a sham. The case was heard before the Jersey reserved powers legislation came into effect, but from the judgment it is clear the legislation would not have saved the trust: the key issue was that the settlor and trustee treated the trust fund as the settlor’s own property.

How to retain influence while avoiding these risks

The reservation of certain powers by a settlor is supported by legislation in several leading jurisdictions, and is perfectly legal, valid and acceptable in the usual course.

One case where a reserved power itself has been held against the settlor is TMSF, and this concerned only the power to revoke. It is not expected that lesser powers, such as the power to invest or to appoint beneficiaries, would be vulnerable in the same way.

Accordingly, there is a balance to be struck. While reservation of powers is a useful planning tool not to be overlooked, settlors and their advisors should take care when considering the reservation of a power to revoke or the reservation of numerous and very extensive powers.

Even without the settlor reserving powers, the trustee has a fiduciary duty to take into account their own wishes (Abacus Trust Company (Isle of Man) and another v Barr and others [2003] Ch 409). A trustee must consider letters of wishes and requests from the settlor and come to its own conclusions in good faith (even absent reservation of an absolute power). If the settlor’s request is reasonable, the trustee may accede to it, even if this is to return substantial funds to the settlor.

Author block
Marcus Leese and Lara Mardell

Marcus Leese TEP is a Partner and Lara Mardell is an Associate at Ogier, Hong Kong.

The content displayed here is subject to our disclaimer. Read more