Trust in the Cayman Islands
Individuals and companies based in the Middle East and North Africa (MENA) region did not escape investment losses during the global financial crisis. Because of recent turmoil, many high-net-worth families in the Middle East have been turning to trust structures to address succession planning and asset protection concerns. Corporate groups in the region have long been using trusts for Islamic finance transactions and employee benefit schemes.
The Cayman Islands is emerging as a natural choice for MENA families and companies to place a trust. Cayman offers a politically stable, tax-neutral jurisdiction with a well-established common-law system and modern, sophisticated trust legislation.
Shari’a and inheritance
Shari’a, which means ‘path’, guides all aspects of Muslim life, including financial dealings and inheritance. Shari’a inheritance law, mainly set out in the Koran, comprises an elaborate system of ‘forced heirship’ rules governing the devolution of property. Unlike many other parts of the world, individuals rather than companies hold most of the assets in the MENA region. As a result, Shari’a inheritance law determines the division of property and dictates the shares and order of precedence in which family members will inherit.
The effects of Shari’a inheritance law may be modified by the use of a Cayman trust. Assets settled into trustinter vivos remain outside the settlor’s personal estate on death and, accordingly, will not be distributed under Shari’a (save to the extent the settlor requires); instead, the assets will devolve according to the terms stipulated by the settlor in the trust deed.
As the trust will be expressed to be governed by Cayman law, all questions arising in relation to the trust, including the capacity of the settlor to create the trust, the validity of the transfer of assets to the trustee and the administration of the trust, will be determined exclusively by Cayman law. Any party wishing to challenge the integrity of the trust will have to do so in the Cayman courts, applying Cayman law. Further, Cayman law specifically provides that no transfer of property into trust is liable to be set aside on grounds that the laws of a foreign jurisdiction do not recognise trusts, or that the trust was set up to defeat foreign heirship or other property rights. A foreign court judgment which is inconsistent with these principles will not be recognised in Cayman.
Succession planning is one of the most significant challenges facing middle eastern families today
It is important to recognise that, typically, clients in the MENA region will not wish to mitigate all aspects of Shari’a when structuring a trust. Usually the trust will be drafted to ensure that its terms, particularly those governing the trustee’s choice of investments, follow the strict requirements of Shari’a. It is common to see an Islamic scholar appointed in the trust deed to advise the trustee on matters of Shari’a interpretation. However, in many instances, a family may determine that its interests will be served better by an arrangement that facilitates the consolidation and conservation of wealth, with management decisions being reserved to appropriate individuals, and distributions to family members being made according to their individual needs.
Family business succession
Recent articles in the MENA press suggest that more than 80 per cent of businesses in the Middle East are family-run or family-owned, with an estimated USD1 trillion expected to be handed down to the next generation in the upcoming five to ten years, and with family businesses controlling more than 90 per cent of commercial activity in the region. A 2007 Ernst & Young survey of businesses in the Middle East revealed that 73 per cent of family businesses surveyed were run by second-
generation entrepreneurs, followed by first- and third-generation owners at 48 per cent and 20 per cent, respectively.
Astonishingly, only 16 per cent of companies admitted to having a well-defined succession and a clear ownership transition plan. Business succession planning, therefore, remains one of the most significant challenges facing Middle Eastern families today.
A ‘STAR’ trust, created under Cayman’s unique Special Trusts (Alternative Regime) Law, can be a particularly helpful vehicle in the context of business succession. This trust provides a flexible and efficient structure that may be established for the benefit of persons or purposes or both. STAR permits the settlor to establish a trust with the dual objects of owning and operating the family business, and providing for future generations of their family. Through this structure, the settlor may identify and prepare their successors and ensure that the business remains intact after their death. Income may be either ploughed back into the business or applied for the benefit of family members.
STAR trusts have the advantages of perpetuity and confidentiality. There is no limit on the duration of a STAR trust, which is attractive to the settlor who wishes to create a ‘dynasty-style’ trust. Under STAR, the settlor is also able to restrict beneficiaries’ ability to obtain information about the trust or to challenge the decisions of trustee. The only party with legal standing to enforce the trust or receive information about it is the ‘enforcer’ nominated by the settlor in the trust deed.
In addition to, or in conjunction with STAR, the private trust company (PTC) is increasingly being used by settlors who wish to retain greater influence over the affairs of the trust. Cayman offers two types of PTC: a fully licensed, regulated form, and a simpler, registered form. These enable the entrepreneurial settlor to incorporate their own trust company to act as trustee of one or more connected trusts. They, or other family members or trusted advisors, will then sit on the board and take an active role in the trustee’s decision-making process. This is perceived as allowing for more flexible, dynamic (and, arguably, less risk-averse) trusteeship.
Asset protection trusts
Cayman’s sturdy – but not overly aggressive – creditor protection laws make it an attractive jurisdiction in which to place an asset protection trust. The legal framework is provided by the Fraudulent Dispositions Law (as revised), which has the effect of rendering any transfer of property voidable by a creditor, if made at an undervalue and with intent to defraud.
Generally, by definition, a gift into trust will be a transfer made at an undervalue. ‘Intent to defraud’ means an intention to wilfully defeat an obligation owed to a creditor that existed on or before the date of the transfer and of which the transferor had notice. The burden of proof is firmly placed on the creditor seeking to set aside the transfer. There is an ultimate limitation period of six years from the date of the transfer into trust, from which point any action to set it aside will be timed out. The legislation is deliberately conservative – a six-year limitation period – rather than adopting the more aggressive approaches taken by some other jurisdictions.
Use of trusts
Cayman trusts are a popular choice for use in Islamic finance structures, e.g. sukuk. The Cayman Islands government has been proactive in amending legislation to characterise sukuk structures as ‘alternative financial investments’ to facilitate the use of Cayman companies and trust structures in Islamic finance without having to comply with the regulatory requirements under the Mutual Funds Law and the Banks and Trust Companies Law.
In the Middle East, many companies are family owned, as noted. Often such companies employ expatriates at management level and wish to reward talented employees and managers under share option or incentive plans. Companies operating in the Middle East, however, face legal restrictions, including maintaining a 51 per cent local ownership requirement, and restrictions on the ability to issue varying share classes.
A STAR trust can help structure share incentive plans for local Free Zone companies and local non-government-owned companies. The trustee acquires a block of shares from the company and/or existing shareholders then arranges transfers of shares forming that block between the trust and employees, pursuant to the share plan and the trust deed. The arrangement limits corporate obligations to issue further shares to employees that could dilute the existing shareholders. Further, use of a Cayman trust avoids the complexity and expense of having to comply with corporate requirements for issuing, transferring and repurchasing shares.
As the fallout from the events of the Arab Spring has clearly demonstrated, the need for robust wealth structuring for individuals and companies in the MENA region has rarely been so pressing. Now, the challenge for trust professionals is to inform them and their advisors that the tools are in place to service that need, and then to work with them to ensure their goals are met.
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