BY SARAH WILLIAMS – PARALEGAL
Southpac has been providing corporate trustee services for over 40 years. During this time, we have come across a wide range of trusts, which are all established for particular reasons, the most common being asset protection.
Some trusts are established by clients with a co-trustee. A co-trustee is a person or entity who is appointed to act as a trustee alongside Southpac and shares the same fiduciary responsibilities and duties as Southpac, and sometimes, may have overall authority to manage the assets and make decisions regarding the trust alone, while Southpac – being the other trustee – would hold the trust assets offshore and record the decisions made by the co-trustee. Some trust settlors prefer co-trustee arrangements because they enable the trust to remain tax-resident in same jurisdiction as the settlor; others choose them because they enable them to retain a greater level of control over the trust fund.
Recently, Southpac has had a close focus on co-trustee structures, and has sought to increase clients’ understanding of the requirements and the legal obligations of Southpac when acting as a co-trustee. We are actively reaching out to clients who have these structures to ensure the integrity of the trust fund is maintained and that Southpac complies with its legal obligations.
A trust must meet the three certainties.[1] These elements must be present for a trust to exist and have been laid down in case law for nearly two centuries.[2] The three certainties are as follows:
- Certainty of Intention. This means to have a certain intention for the creation of a trust.[3]
- Certainty of Subject. This requirement refers to property that is held in trust for beneficiaries.[4]
- Certainty of Object. This means that the beneficiaries of the trust must be clearly identified.[5]
The Certainty of Intention is most likely to be challenged in an offshore co-trustee arrangement by a creditor claiming the trust to be a sham.
When a creditor claims that a trust is a sham, they are alleging that the trust is not a genuine, legitimate trust, but rather an artificial arrangement that was created with the intention of avoiding the creditor’s claims.[6] If Southpac, being a co-trustee of a trust, holds no information of the assets held in the trust, no information of distributions and contributions from and to the trust, or no information of the actions taken by the co-trustee, and only acts as a co-trustee for the purposes of making it possible for the trust to be registered in the Cook Islands or Nevis – and to obtain all the asset protection benefits of those jurisdictions – a creditor may argue that the trust was created solely for the purpose of avoiding payment of debts, defrauding a specific creditor or avoiding other legal obligations.
If a court determines that a trust is a sham, it may set aside the trust and allow the creditor to pursue collection against the assets held in the trust. In this article, we will examine two different co-trustee arrangements to illustrate the difference between a good arrangement and a risky one.
Case Study 1 – How to Maintain a Co-Trustee arrangement
In this case, Jane, a businesswoman, is the settlor of a Cook Islands international trust. Jane’s brother Michael is named as a co-trustee, to act together with Southpac. Michael retains powers to make sole decisions to bind the trust without the need to obtain Southpac’s consent or participation.
The Trust holds several million dollars and is intended to provide for Jane’s children, herself and to minimise her taxable estate. The trust also holds a US based limited liability company, of which Jane is the manager.
Jane, Michael and Southpac have open communication and a shared commitment to ensuring that the trust is managed responsibly and in accordance with Jane’s wishes, for the benefit of the trust beneficiaries and in accordance with the terms of the trust agreement and operating agreement of the LLC.
All parties and Southpac have clear procedures for decision-making, asset management and reporting. When Michael makes trustee decisions, he provides updates and supporting documents to Southpac, so Southpac can appropriately update their records. This protects the integrity of the trust fund by minimising the risk of a creditor claiming that the trust is a sham. Furthermore, this ensures that Southpac cannot be penalised by regulators for having incomplete records or know your customer due-diligence documentation.
Jane notifies Southpac each time assets are transferred from her, in her position as settlor, directly into the LLC, so that both Southpac and Michael can record the transaction as a gift to the trust, followed by an immediate capital contribution made by the trustees to the LLC, as members. This maximises the asset protection available and ensures that no challenge to the Trust for lack of Certainty of Subject or Intention can be made.
Michael also notifies Southpac each time Jane, as manager of the LLC, wishes to transfer funds out of the LLC to a beneficiary of the trust, so that this can be recorded as a capital distribution to the trustees, as members, immediately followed by a beneficiary distribution from the trust.
When Jane’s latest business venture encounters legal problems, an attorney acting for a creditor of the LLC files a lawsuit claiming the trust to be a sham.
Southpac, Jane and Michael are confident the trust assets are protected because they can prove the trust is genuine and legitimate, with all parties involved properly playing their part, properly recording assets and decisions and sharing information with each other.
Case study 2 – A Badly-Managed Co-Trustee Arrangement
Peter is a high net worth individual and sets up a Nevis Trust with the intention of protecting his assets from potential legal liabilities that may arise in the course of his business activities. He is a real estate developer. In this trust, Peter is the settlor, protector, sole beneficiary and a co-trustee retaining powers to make sole decisions to bind the trust without the need to obtain Southpac’s consent or participation.
The trust holds a US based limited liability company, of which Peter is the manager.
Peter regularly settles assets in and out of the LLC. He assumes that if he is ever in legal trouble, the trust will be able to protect the assets he has settled into the LLC.
Peter has never contacted Southpac to provide information about decisions made by him as a co-trustee or as manager of the LLC, of about any assets gifted by him to the LLC or distributed to him as a beneficiary of the trust. Southpac therefore holds no information about the assets comprising the trust fund or of any actions taken under the trust.
In light of the situation, a creditor has successfully argued in court that the trust was a sham because:
- Peter did not relinquish control or effective ownership of the assets. He was a co-trustee with powers to act alone, the sole beneficiary of the trust and the sole manager of the LLC which held significant assets. He had no dealings with Southpac, the independent co-trustee, and treated all assets as if they were his own personal property. He never intended to create a genuine trust, only an arrangement that was dressed up to look like one. The trust failed for Certainty of Intention.
- Southpac, as co-trustee, was unaware of what the trust fund consisted of and did not accept any assets into the trust. Similarly, Peter did not record the addition of any assets to the trust in his capacity as co-trustee. Therefore, the Certainty of Subject element of the trust was missing.
The court also held that there was a fraudulent transfer because the settlor was aware of a judgment against his assets and settled the assets to avoid making payment. Peter is ordered by the domestic court to transfer the assets held by the LLC to the creditor.
After receiving the court judgment, Peter resigns as co-trustee and claims that the assets in the trust cannot be transferred to the creditor because he has no power to transfer them. He argues that the creditor will need to bring proceedings against Southpac in the Nevis High Court to obtain the funds. While this is correct, and will be a major deterrent to the creditor, the domestic court rules that Peter has created this impossibility himself, finds him in contempt and imprisons him until he arranges for the assets to be transferred to the creditor. He cannot be held indefinitely, but US courts have been known to hold debtors in prison for several months or even years in situations such as this.
Conclusion
These two case studies illustrate the difference between an appropriately managed co-trustee arrangement and one that is not. They demonstrate the importance of co-trustees working together to establish clear guidelines and procedures and freely provide information and documentation to each other. This ensures that the trust is valid and is maintained in a way which is beneficial to its beneficiaries.
Southpac works closely with clients to avoid any scenario whereby a creditor can claim that a trust is a sham. We reach out annually to all clients with a co-trustee arrangement to ensure that we can properly acknowledge and record decisions made by co-trustees and acknowledge all assets forming part of the trust fund. This protects the integrity of the trust and provides additional protection.
[1] Knight v Knight (1840) 49 ER 58
[2] Financial Markets Authority v Hotchin [2012] NZHC 323 at [27]
[3] Paul v Constance [1977] 1 WLR 527 (CA)
[4] Boyce v Boyce (1849) 60 ER 959
[5] McPhail v Doulton [1971] AC 424
[6] This is a common law principle that was established long ago. See Chudleigh’s Case (1594) 1 Co Rep
