Trust Estate

GUEST ARTICLE: “Stress-Testing” Trusts In An Unstable World

Lara Crompton and Steven Kempster Withers 24 August 2016

GUEST ARTICLE: “Stress-Testing” Trusts In An Unstable World

In this article, law firm Withers reviews trust structures in unstable countries where wealthy families live or operate their businesses.

In a hypothetical scenario where officials seek to cause as many problems as possible for individuals who may be targeted by the ruling political regime, can steps be taken to shore up the protection offered by trust structures? Lara Crompton, associate, and Steven Kempster, partner, of Withers discuss. 

As always, the editors of this publication do not necessarily endorse all the views of guest contributors but are happy to share them and welcome responses.

For many high net worth families or family offices, the to-do list of important tasks should include a regular review of any trust structures to ensure they meet the needs of the family (including asset protection, tax and/or family governance considerations) in the most efficient way. The recent failed coup in Turkey is just one reminder that many areas of the world do not benefit from the political stability that the UK (generally - some would say pre-Brexit) enjoys and if the region in which the family lives or operates their businesses (‘the home jurisdiction’) is undergoing upheavals, then the context of that review needs to be tailored to particular risks that arise from that instability. 

Advisors should carry out a thorough review of the trust structures in the context of potential routes of attack under a hypothetical scenario in which officials of the ruling regime (wanting to distract and cause difficulties for power-holders, trustees and beneficiaries, never mind the success of a particular line of attack) launch attacks on trust structures or their assets. The review should identify the particular vulnerabilities of the structures and enable analysis of the extent to which steps could be taken to address the risks and whether, ultimately, the risks are best addressed by replacing the current structure with a new one.

Potential routes of attack
Potential routes of attack might include any of the following:
1.    Expropriation of assets;
2.    Imposing restrictions on individual power holders with connections in the home jurisdiction;
3.    Direct attack against a trust or holding company; or
4.    Orchestrating bankruptcy or incapacity of a power holder.

These are considered in further detail below with a brief discussion of practical steps to address the risks.

1. Expropriation of assets

Risk - Any attempt by the ruling regime to expropriate assets could have a hugely damaging effect on the family’s businesses and financial well-being.

Step - An essential step would therefore be to review the level of protection provided by any relevant investment treaties and to seek advice regarding whether steps can be taken to bolster that protection.  Click here for further discussion from Withers on investment treaty protection. 

2. Imposing restrictions on individual power holders with connections in the home jurisdiction

Risks - If key individuals are subjected to travel bans, restrictions on communications or even incarceration, this could make it difficult or impossible for those individuals to exercise powers that may be essential to the running of the structure.

Steps - If significant powers lie with individuals who may be targeted by the ruling regime, it would be helpful to redistribute some of those powers, or include a check so that the powers are not exercised whilst under duress.  However, there is a delicate balance to be struck because such a step, although optimal from a purely asset-protection perspective, is likely to conflict with the family’s desire to maintain a level of influence over the structure. It may also trigger tax, reporting or other consequences. The right approach is therefore a discussion of the level of risk for each power and a menu of options to address that risk. 

If important roles such as the protector are currently held by a single individual, consideration should be given to creating committees and appointing committee members who are resident outside the unstable region to limit the damage that the successful imposition of restrictions on that individual could cause. Care is needed to ensure voting arrangements give the family the level of influence that they feel comfortable with. 

If a trust qualifies as a grantor trust for US tax purposes, then, if it is desirable to maintain that status, rather than the settlor releasing certain powers, it will be necessary to subject them to a consent requirement (with an appropriate consent holder mechanism). 

3. A direct attack against a trust or holding company

Risks - This could take the form of an action in the courts of the jurisdiction under whose law the trust is governed (‘the trust jurisdiction’) claiming that the trust is invalid or, more likely, an attempt to enforce a judgment obtained in the home jurisdiction against assets held by the trustees. An attempt to pierce the corporate veil of a holding company, or claim that the company is simply a nominee for the 'true' owner,  could be made in order to seek access to the underlying assets.

In terms of attacks on the trust itself, while it is highly unlikely that an allegation of a sham trust will have much chance of success where there are reputable professionals involved either as trustees or directors of the private trust company, if significant powers vest in one individual, this leaves the structure vulnerable in two ways: (1) if the home jurisdiction is successful in imposing restrictions on this individual, as above, the impact on the trust structure and its assets could be catastrophic; (2) it allows the possibility of an attack based on such individual being treated as a de facto trustee. An antagonist could mount a challenge to a trustee decision on the grounds that the decision was not properly taken by the trustees, but by the de facto trustee.

When reviewing the current structure, it is crucial to take an honest look at the reality of how the trust operates in practice.  Any departure from the trust instrument or other supporting documentation such as operating manuals etc. could allow a foothold for an opportunist antagonist. For example, any instance of a director treating company funds as his own, particularly if he has sole signing authority over the bank account, may be used as ammunition to attempt to side-step the trust or corporate structure.

Steps – Redistribution of powers would help with this risk, as well as the risk mentioned above.
A possible step to help protect one asset class from becoming “tainted” if another asset class (perhaps with a greater connection to the home jurisdiction) comes under attack would be to segregate assets into separate trusts with a different trustee. Whether the expense of additional structures is justifiable would need to be weighed against the level of risk. 

4. Orchestrating bankruptcy or incapacity of a power holder

Risks - It is conceivable that the government could orchestrate the bankruptcy of an individual who is the holder of a significant power in the trust. This could risk ceding effective control over the trust to a government-appointed receiver. In 2011 , the Privy Council allowed a settlor’s receivers in bankruptcy to take over his powers of revocation in relation to two Cayman trusts, treating the powers, in effect, as though they were part of the settlor’s estate subject to the bankruptcy.   

Similarly, unless there is appropriate protection in the trust instrument, under a potential scenario involving the government arranging for doctors to declare a power holder to be incapacitated, an official could be appointed to exercise his powers. 

Steps - Various amendments to the trust could significantly decrease these risks and are unlikely to be controversial. These might include: (i) tightening the requirements for declaring an individual incapacitated to safeguard against the concern that the home jurisdiction could influence its doctors; (ii) ensuring that if a power-holder is incapacitated, trusted individuals can exercise his powers instead of risking the powers being exercised by an official appointed by the ruling regime.

Should the trust stay or go?

In considering whether or not to retain the current trust structure, it should be borne in mind that collapsing the structure and transferring assets to a new structure would risk losing the protection afforded by the current structure and leave the assets transferred more directly exposed to the risk of fraudulent dispositions and/or tracing claims. Future creditors cannot attack the transfer into trust under an argument that the settlor intended to prejudice his existing creditors if the limitation period has expired.  However, expiration of the limitation period would not protect the trust from legal and equitable tracing claims challenging transfers of assets because (it is alleged) the settlor did not own them. 

The robustness of the “firewall” under the law of the trust jurisdiction should be considered in comparison to the firewall protection available under other suitable alternative jurisdictions. For robust jurisdictions, such as Cayman, all questions concerning the disposition of property to a Cayman trust should be determined by reference solely to the law of the Cayman Islands, to the exclusion of all foreign laws. Thus an order of a court in the home jurisdiction concerning the transfers to the trust is unlikely to receive automatic recognition in Cayman. 

Whether or not steps are taken to bolster protection of the structure, it may be appropriate to establish a cash trust to ensure that if any beneficiary or power-holder needs access to cash there is an emergency fund available (if other assets are subject to freezing orders or similar). This fund could prove to be a valuable precaution so that swift action can be taken to limit potential damage where an attack on the trust is launched. 

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